Portfolio return calculation – ignored and misunderstood
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Portfolio return calculation – ignored and misunderstood

Why do schools have report cards for students at the end of each term? To assess if the material taught was understood by students.

For stock markets, the relevant report card is portfolio return (along with relevant risk metrics). Yet, most investors (both institutional and individual) in our country, either do not calculate their returns or make calculation mistakes that make the numbers useless.

Most investors do not calculate returns in Bangladesh!!!

As surprising as it may sound, the above statement is true. Most investors in Bangladesh rely on the broker provided portfolio statements to track portfolio performance. The information provided in those statements is inadequate to measure returns. They only provide a snapshot at a specific period in time which does not consider the length of investment or inflows/outflows made.

What is more surprising is that the institutional investors including banks, merchant banks, brokerages, insurance companies are making the exact same mistakes as the retail investors. They remain unaware of the necessity to calculate returns correctly and presenting to top management.

Not using market values to calculate returns

Another common mistake is ignoring the market value of the portfolio. Investors consider only ‘realized gains/losses’ on stocks as material. Thus unrealized losses are often not counted as losses, even though they actually are. This leads to extra‘loss aversion’ bias as people hold on to losing positions for years.

In a similar fashion, portfolio statements provided by brokers show unrealized/realized gains without indicating the length of the investment. An investment made 20 years back at a cost of BDT100 may have a market value of BDT200 now indicating 100% gain. Without considering the 20 years, this would look like a remarkable investment on paper and even when the shares are sold. Yet, when time value is taken into considering this investment has clearly generated below par returns.

Introducing time weighted stock returns

The solution to all the problems is ‘time-weighted returns‘. The concept is very simple. Firstly, we use the market value of assets to calculate returns for each reporting period. Secondly, we need to adjust our calculations for inflows to and outflows from the portfolio.

Time-weighted return calculation is done globally by investment professionals and is not a new concept. It is, however, something that is yet to be understood in Bangladesh.

Conclusion

Imagine a bank trying to decide whether their current fund manager is performing. Or an individual relying upon his stockbroker to manage his entire savings. How will the bank or the individual know whether their fund manager is doing a good job? Not possible if returns are not recorded properly.

There are two solutions to this problem. Firstly, clients can maintain excel files separately that calculates stock returns properly (our next post will show how to calculate such returns). Alternately, stockbrokers can improve the software solutions they are using that will do this automatically for clients. The latter is the better solution in our view but until technology improves the investors have to do it themselves.

In our next blog post, we will delve deeper into the calculation of time-weighted returns. Stay tuned.

This Post Has 2 Comments

  1. Thank You for your valuable information about that and will wait for the next blog.

  2. Thank you so much for such kind of post that is vital and improves investors knowledge. Eager to wait for details on how to calculate the return. If possible add a sample excel file that can be very useful for general investors. Thank you again and hope more vital post in the near future.

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