Performance measurement is a regular R02 topic, and the exam reliably tests the difference between two return measures: money-weighted and time-weighted. They sound similar but answer completely different questions.
The two measures in one sentence
- Money-weighted return (MWR). The investor's personal return, sensitive to when money was added or withdrawn. Mathematically, it's the internal rate of return (IRR) of the portfolio's cash flows.
- Time-weighted return (TWR). The fund manager's return, ignoring the timing and size of the investor's contributions. It chains together the return of each sub-period.
Worked example, same fund, two answers
You start the year with £10,000. After 6 months, the portfolio has grown to £11,000. You add £10,000, so the portfolio is now £21,000. By year end, the portfolio is worth £23,100.
Time-weighted return
Split into two periods and chain the returns.
- Period 1 (Jan, Jun): 11,000 ÷ 10,000 = 1.10 → +10%
- Period 2 (Jul, Dec): 23,100 ÷ 21,000 = 1.10 → +10%
TWR = (1.10 × 1.10) − 1 = 21%
The fund manager produced 10% in each half-year, regardless of when the investor added cash.
Money-weighted return (IRR)
Cash flows from the investor's perspective:
| Time | Cash flow |
|---|---|
| Day 0 | −£10,000 (investment) |
| Month 6 | −£10,000 (top-up) |
| Year end | +£23,100 (final value) |
Solve for the discount rate r that makes net present value = 0. The IRR here works out to roughly 17-18%, lower than the TWR because the investor put more money in after the early gains.
When R02 expects each
| Use case | Right measure |
|---|---|
| Comparing fund managers | Time-weighted (strips out cash-flow timing) |
| Measuring an investor's actual experience | Money-weighted |
| Performance reporting standards (GIPS) | Time-weighted |
| A pension scheme's own funded position | Money-weighted |
How to remember the difference
- TWR rewards the manager. It's their return per pound, regardless of when the pounds turn up.
- MWR rewards the timing, if you bought low and added at the top, MWR will be lower; if you added at the bottom, MWR will be higher than TWR.
Common R02 traps
- Confusing them when contributions happen. If there are no inflows or outflows during the period, MWR = TWR. The two only diverge when cash flows enter or leave.
- Calling MWR an "annualised" return. It can be annualised, but the raw IRR is the rate that makes NPV zero, not always per-year.
- Picking TWR for a personal-experience question. "What return did the investor actually get?" → MWR.
- Forgetting compounding direction. Withdrawals reduce the base for future returns; deposits increase it.
R02 exam framing
You'll typically see one of three formats:
- A multiple-choice asking which measure is appropriate for a given scenario.
- A short calculation where TWR is asked for (because IRR is hard to do by hand), chain two or three sub-period returns.
- A definitional question on why GIPS-compliant performance reporting uses TWR (so investors can compare managers fairly).
Lock down the conceptual difference first, then practise chaining 2-3 sub-period TWR calculations under exam conditions. That's the whole topic.