Dollar-weighted returns

CFA Level I Portfolio Management
#1

Hi all,

I am always a bit unsure about how to calculate dollar-weighted returns, and I mainly don’t know how to determine what is a cash inflow and what is a cash outflow…that would depend on your point of view right? Let’s see an example below:

A fund is worth initially $1100. Six months later the fund is worth $1200. Another $500 is invested at this point. At the end of the period, the fund has increased in value to $1800. Please calculate the dollar-weighted returns.

First of all, what is my point of reference. Is any money that goes to the fund a cash inflow?

Inflow: $500. Outflow: ??? fund’s end value?

Appreciate any clarifications!

#2

Take the point of view of the portfilio: the $500 is an inflow, as the $500 came into the portfolio.

#3

So what about outflow? the end portfolio value? it doesn’t make sense to me.

#4

Think of it this way: at the beginning the investor deposits the money into the portfolio account, and at the end the investor removes the money from the portfolio account. Thus, the initial value is a cash inflow and the terminal value is a cash outflow.

#5

Basically you can take the view of the portfolio as described by S2000magician or you can take the view of the investor (opposite signs). The resulting IRR will be in both cases the same. You just have to be consistent with the view taken and apply the signs accordingly.

Inverstor view: -1,100 / -500 / +1800

Portfolio view: 1,100 / 500 / -1800 In both cases the IRR will be 7.19%

#6

Thanks! I see it now. But say, from the fund’s point of view, why didn’t we take $1200 into account somehow? Since the fund started with a value of $1100, so there’s an inflow of $100?

#7

The fund’s job is to earn money. The cash flows that we use to compute IRR are cash flows _ other than _ the fund doing its job (which is what we’re trying to measure).