Computing ROR in Managed Accounts

Rate of Return (ROR) is the net performance of an investment for a specific period, divided by the BNAV for that period. While this is an accepted method, it is not necessarily accurate in all cases. The computation assumes that 100% of assets were invested on day one and remain so throughout the period. If additions or withdrawals were made (especially large ones in the early part of the period) then the ROR could be well off. Therefore we can use more precise methods as the ones below so long as the results represent a true characterization of the returns.

The “Time-Weighting” Approach:

This analysis adjusts the BVNAV according to the time and amounts of additions and withdrawals. For additions, the time-weighting represents the percentage of the month for which funds were available, while for withdrawals the time weighting represents the percentage of the month for which funds were unavailable. For example, if the actual BNAV was $1,000,000 and an additional $1,200,000 was deposited on the 10th of the month, and $600,000 was withdrawn on the 20th of the month, the BNAV would be adjusted upward by $800,000 (because the $1,200,000 added was available for two thirds of the month) and downward by $200,000 (because the $600,000 withdrawn was unavailable for one-third of the month). Therefore, the adjusted BNAV would be $1,600,000, a 60 percent increase over the actual BNAV. Thus, if the net performance for the month equaled $100,000, the ROR would be 6.25 percent instead of the 10 percent that would have been implied using the actual BNAV.

The “Compounded ROR” Approach:

In this method, the ROR is calculated for each sub-period between additions/withdrawals (as if each such sub-period were itself an entire month). As the name implies, the compounded ROR for the entire month would be equal to the compounded return for the sub-period. For example, assume a $50,000 starting equity and the following sub-period returns and additions/withdrawals:

Computing ROR in Managed Accounts

In this example, the compounded ROR would be equal to ENAV/BNAV = 0.3064 = 0.038%.

The compounded ROR method will precisely reflect the return realized by accounts that did not experience any additions or withdrawals during the month, given the following set of assumptions: (1) in actual trading, the CTA adjusts the trading leverage daily to account for changes in equity, and (2) the sub-periods in the compounded ROR calculation are days.

The “Only Accounts Traded” Approach:

This approach, known at “OAT” analyzes the monthly return by excluding any accounts that traded only for a part of the month, or that had significant additions or withdrawals. The result would look very much like the ROR of a single investor who began the month at a certain amount, and did not make any additions or withdrawals.

Regardless of the method used, any pool operators or account managers must disclose to prospective investors which of these approaches was used in computing the ROR.

Computing ROR for Partially-Funded or Notionally-Funded Accounts

When the Nominal Account Size is different than the actual funds on deposit in the client’s account, the account is considered to be notionally funded. Nominal Account Size is the actual funds on deposit plus notional funds. CTAs must calculate ROR using the nominal account size. If an account is partially funded, the CTA must maintain written confirmation of the nominal account size agreed to by the client and the CTA.

Annual and Year-to-Date Rates of Return

Annual RORs can be calculated using the Compounded ROR method described above or the Value Added Monthly Index (VAMI) method. The VAMI method generally assumes an initial investment of $1,000 and shows how such an investment would have fared over a certain period of time. In order to calculate annual ROR using VAMI, you must first calculate the value of the $1,000 investment at the end of each sub-period or month based upon the monthly RORs computed in accordance with one of the above mentioned methods. The calculation would be as follows:

In the first month of the period:

VAMI for month = (1 + ROR for month) x 1000

For all subsequent months:

VAMI for month = (1 + ROR for month) x VAMI for prior month

Annual ROR would then be calculated as follows:

Annual ROR = (year-end VAMI – $1,000) divided by $1,000.

When calculating the annual RORs for subsequent years, the value of the initial investment should be the prior year-end VAMI.

Computing Monthly and Peak-to-Valley Draw-Downs:

A “Draw-Down” is the greatests loss in a trading account over a particular month or other designated period. If it is expressed as the “worst” draw-down then it means the lowest rate of return during the period.

Another metric often seen is the “Peak-to-Valley” draw-down. This calculation is usually made over a longer period of time, such as the life of the account. It’s measured at month-end, and represents what it sounds like: the difference between the highest high and any subsequent lows in net asset value.

The peak month and the valley month should be reported in the disclosure capsule. Note that when a draw-down begins in one year and ends in another, it is stated such that it will have existed during a five calendar year period.