The Two Faces of Investment Performance and Risk

Abstract

Investment concepts are generally taught, learnt and spoken about amongst professionals in time-weighted terms. According to this view of the world, returns are the sole determinant of performance and risk, and a given return has an identical impact no matter its timing. While appropriate in certain circumstances, time-weighted returns (TWRs), and the performance and risk measures derived from them, provide an incomplete picture when evaluating certain practical financial problems, like retirement investing. For example, we know that other variables - including current member balance, contribution rate, age, targeted retirement date and objective - are important factors in determining investment outcomes. This paper discusses the distinction between TWRs and more comprehensive measures, and employs a range of performance and risk measures from each category in comparing a number of extant investment strategies. We find that time-weighted measures overlook important aspects of retirement investing, whereas wealth-denominated, target-relative measures more accurately capture the dynamics of retirement investing. Thus we see the two faces of investment performance and risk. The paper concludes by discussing how these two classes of measures might be incorporated into investment governance at superannuation funds.