Guidelines For The Calculation Of Time Weighted Rate Of Return

By Rodrick Wiyo
2011
Performance measurement is regarded as an important aspect of foreign reserves management. It lays the foundation for all further analysis in the field of investment management. It can be considered a risk management and control tool that assists reserves managers in analysing performance and identifying sources performance. Central banks, especially in the MEFMI region, have taken an added interest in performance measurement owing to an increase in general awareness of the concept on one hand and the phenomenal growth in foreign reserves under their management on the other. The recent developments in global financial markets however have raised serious questions about the management foreign reserves at both country and regional levels. Issues of performance measurement and risk management often come to the fore as countries revaluate their foreign reserves management strategic asset allocations and strategies. The previous edition of the paper attempted to explain one particular measure of return, the Time Weighted Rate of return, and just explained in passing, several risk adjusted measures return. In this edition however, the subject of risk adjusted measures is given its proper place in reserves management by expanding one such measure, the Tracking Error. Furthermore, the global financial crisis has exposed the flaw of “herd behaviour”, whereby it has been observed for example that as central banks moved their huge reserves into the safety of G7 government bonds markets (the US in particular), yields in those markets virtually dried up. The global crisis notwithstanding, countries in the region have been accumulating reserves hence necessitating revision of earlier conclusions and observations.
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As a group, MEFMI member countries held around USD39.874 billion in foreign assets as of end December 2009, nearly trebling their holdings from a decade and half ago (see chart 1 in appendix 1). Foreign reserves have grown by a multiple of 7 times from a total of USD 4.75 billion in 1990 to USD 39.874 billion in 2009 ( See Table 1 in Appendix 1). There has however been varied performance in terms of accumulation of foreign reserves by individual MEFMI members over the review period (1990 to 2009). For example, seven countries have achieved accumulation rates higher than the MEFMI period average (see table 1). Furthermore during the period under review, seven countries, Angola, Kenya, Mozambique, Namibia, Tanzania and Uganda have joined Botswana in the club of countries with over USD 1 billion in foreign reserves. A closer look at the percentage holdings of foreign reserves per country in the MEFMI region shows substantial shift in the holdings. Notably, whereas Botswana accounted for almost two thirds of all foreign reserves held by all MEFMI member countries in 1990, at the end of 2009, it only accounted for only 21 percent of the foreign reserves (see chart 2 in appendix 1). Angola, thanks in part to its huge oil reserves, accounts for most of the growth in foreign reserves. The impact of the global crisis on the rising trend in accumulation of foreign reserves has been minimal in the region. Lastly some countries like Malawi, Swaziland and Zimbabwe (see table 1) have registered stagnated growth in their foreign reserves.

As the majority of MEFMI member countries were experiencing this unprecedented growth in foreign reserves, one would have expected corresponding development in foreign reserves management systems and procedures. However, this has not found to be true. The system and procedures are still not well developed in the majority of member countries and hence the need to have some precise guidelines regarding performance measurement tools and techniques to assist the countries in the MEFMI region. MEFMI has generally assisted countries in the region in adopting best practices in reserves management, but there is still a gap in as far as development of middle offices functions in general and performance measurement and monitoring systems tools in particular are concerned. This paper therefore is an attempt to fill that gap and come up with guidelines for performance measurement, monitoring and evaluation in line with global standards. The paper will specifically zero in on the Time Weighted Rate of Return (TWR) as a performance measure and try to document procedures that need to be followed in order for a country to set up a simple and effective system.

A snap survey (see appendix I) reveals that almost 50 percent of central banks in the region are using the time- weighted rate of return as a performance measure; however, they do lack a specialized system and/or procedures for performance measurement and reporting. In addition, as the survey also revealed that almost all central banks are using Microsoft Excel in their daily operations, there is a need to develop the simple procedures that could easily be implemented in Excel. The paper attempts to document the procedure for proper calculation of Time Weighted Rate of Return that might be incorporated in future amongst the MEFMI countries for middle office operations. Following uniform procedure amongst MEFMI members will promote fair and acceptable comparison for performance measurement in the region.