Overselling time-weighting

For some time it's been my view that time-weighting was oversold.

That is, when nearly 50 years ago (1966, to be exact) Peter Dietz published his dissertation, promoting a return method to eliminate or reduce the impact of cash flows, his idea was so powerful and intriguing that it caused the Bank Administration Institute (BAI) to publish the first set of performance standards (1968), which encouraged the use of (what they called) time-weighted methods, to eliminate or reduce the effect of cash flows. This was followed by the ICAA (now the IAA) in 1971, with a different set, but that also promoted time-weighting.

The industry's response was as you might expect: acceptance. Because there had been no rule regarding how to calculate returns and, as Peter discovered, the result was a mix of methods, most of which were simply wrong.

But Peter never intended to have pension funds, etc. to stop using the IRR (money-weighting). On the contrary, he, and many others (such as the UK's Dugald Eadie), identified the role of this method. But, either because of the inability to grasp what Peter, Dugald, and others were saying, or not even paying close enough attention, the use of the IRR as a method to evaluate a plan or account from the client's perspective disappeared.

I liken this overselling to the case involving a Catholic girl and a Baptist boy who were dating. The girl's mother recognized that marriage was a possibility, and suggested that it would be a good idea if she could persuade her boyfriend to convert to Catholicism. And so, the daughter began working on him, taking him to church regularly, explaining the rituals, etc. A few months later, in tears and sadness she phoned her mother to explain that the marriage wasn't going to happen. "Why, weren't you able to sell him on the Catholic religion and get him to convert?" The daughter replied, "yes, but I think I overdid it; he's decided to become a priest!"

Like the girl in this story, the industry was oversold. Fortunately, there are several of us who are encouraging firms to reconsider the use of money-weighting, and meeting with a fair degree of success.