Simple Dietz method: Difference between revisions

Revision as of 06:07, 19 August 2016

Revision as of 08:05, 13 October 2016

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The '''simple Dietz method''' is a means of measuring historical investment portfolio performance, compensating for external flows into/out of the portfolio during the period.<ref name="Schwab2007">{{cite book|author=Charles Schwab|title=Charles Schwab's New Guide to Financial Independence Completely Revised and Upda ted: Practical Solutions for Busy People|url=httphttps://books.google.com/books?id=QMjjIm2m2ZMC&pg=PA294|date=18 December 2007|publisher=Doubleday Religious Publishing Group|isbn=978-0-307-42041-1|pages=259–}}</ref> The formula for the simple Dietz return is as follows:

:<math>R=\frac{B - A - C}{A +C/2}</math>

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# The simple Dietz method is a variation upon the simple rate of return, which assumes that external flows occur either at the beginning or at the end of the period. The simple Dietz method is somewhat more computationally tractable than the [[internal rate of return]] (IRR) method.

# A refinement of the simple Dietz method is the [[modified Dietz method]],<ref name="FischerWermers2012">{{cite book|author1=Bernd R. Fischer|author2=Russ Wermers|title=Performance Evaluation and Attribution of Security Portfolios|url=httphttps://books.google.com/books?id=nnSmFa9mrvUC&pg=PA651|date=31 December 2012|publisher=Academic Press|isbn=978-0-08-092652-0|pages=651–}}</ref> which takes available information on the actual timing of external flows into consideration.

# Like the modified Dietz method, the simple Dietz method is based on the assumption of a simple rate of return principle, unlike the internal rate of return method, which applies a compounding principle.

# Also like the modified Dietz method, it is a money-weighted returns method (as opposed to a time-weighted returns method). In particular, if the simple Dietz returns on two portfolios over the same period are <math>R_1</math> and <math>R_2</math>, then the simple Dietz return on the combined portfolio containing the two portfolios is the weighted average of the simple Dietz return on the two individual portfolios: <math>R = w_1 \times R_1 + w_2 \times R_2</math>. The weights <math>w_1</math> and <math>w_2</math> are given by: <math>w_i = \frac{A_i +\frac{C_i}{2}}{A_1 + A_2 +\frac{C_1+C_2}{2}}</math>.

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:"The method selected to measure return on investment is similar to the one described by Hilary L. Seal in ''Trust and Estate'' magazine. This measure is used by most insurance companies and by the SEC in compiling return on investment in its Pension Bulletins.<ref>{{cite journal|last1=Seal|first1=Hilary L.|title=Pension & Profit Sharing Digest: How Should Yield of a Trust Fund Be Calculated?|journal=Trust and Estates|date=November 1956|issue=XCV|page=1047}}</ref> The basis of this measure is to find a rate of return by dividing income by one-half the beginning investment plus one-half the ending investment, minus one-half the investment income. Thus where ''A'' equals beginning investment, ''B'' equals ending investment, and ''I'' equals income, return ''R'' is equivalent to

::<math>R = I \div {1/2} (A + B - I)</math>

:For the purpose of measuring pension fund investment performance, income should be defined to include ordinary income plus realized and unrealized gains and losses."<ref>{{cite book|last=Jacobson|first=Harold|title=MEASURING INVESTMENT PERFORMANCE|url=httphttps://books.google.com/books?id=7_ZOAgAAQBAJ|year=2013|publisher=Author House|isbn=978-1-4918-3023-9|page=[https://books.google.com.ph/books?id=7_ZOAgAAQBAJ&pg=PA48 48]|ref=harv}}</ref>

:"The investment base to be used is market value as opposed to book value. There are several reasons for this choice: First, market value represents the true economic value which is available to the investment manager at any point in time, whereas book value is arbitrary. Book value depends on the timing of investments, that is, book value will be high or low depending on when investments were made. Second, an investment manager who realizes capital gains will increase his investment base as opposed to a manager who lets his gains ride, even though the funds have the same economic value. Such action would result in an artificially lower return for the fund realizing gains and reinvesting if book value were used."<ref>{{harvnb|Jacobson|2013|p=49}}</ref>

Using <math>M_1</math> and <math>M_2</math> for beginning and ending market value respectively, he then uses the following relation: