SEBI has fundamentally transformed how portfolio management services report performance through the mandatory adoption of Time-Weighted Rate of Return (TWRR). This article explains what TWRR is, why SEBI mandates it, and how portfolio managers must comply.
What is TWRR?
Definition
TWRR is the return on Re 1 invested from beginning to end, assuming no subscriptions and withdrawals. It measures the compound growth rate of a portfolio by eliminating the distorting effect of external cash flows.
Key Characteristic
TWRR eliminates the effect of both timing and amount of money at work. This means the return reflects the portfolio manager's investment decisions rather than the client's timing of contributions or withdrawals.
Calculation Method
TWRR can be computed using market value or unitized method. The unitized method involves creating units for the portfolio and calculating returns based on unit price changes, similar to mutual funds.
Why SEBI Mandates TWRR
Elimination of Timing Effects
Previously, portfolio managers used weighted average returns which were influenced by the timing and size of client contributions. TWRR eliminates these extraneous effects, providing a pure measure of investment skill.
Standardization Across Managers
The mandate ensures uniform performance reporting across the industry. Investors can now compare performance across different portfolio managers on a like-for-like basis.
True Performance Measurement
TWRR measures the compound growth rate of a portfolio, reflecting the manager's actual investment decisions rather than client behavior.
Alignment with Global Standards
TWRR is the globally accepted standard for measuring investment manager performance, bringing Indian PMS practices in line with international norms.
Regulatory Requirements
Mandatory Calculation
The performance of a discretionary portfolio manager shall be calculated using time-weighted rate of return (TWRR) for the immediately preceding three years. Performance indicators shall also be disclosed.
Inclusion of All Holdings
All cash holdings and investments in liquid funds must be mandatorily included in TWRR calculation. Returns less than one year should not be annualized.
Net of All Fees
Performance has to be reported net of all fees, all expenses and taxes. This ensures investors see the actual returns they would receive.
TWRR in Marketing
Portfolio Manager shall present the TWRR of the Investment Approach along with the trailing return of the selected benchmark when communicating, advertising, publishing, or mentioning performance of an Investment Approach.
Investment Approach Level Reporting
Change from Firm-Level
Previously, performance reporting was done at firm-level using weighted average return of all portfolios. Now, in addition to firm-level, investment performance is to be reported at investment approach level too.
IA-Level TWRR
The return will now be calculated for all portfolios in an Investment Approach. Different numbers will be provided for different investment approaches.
Client Reporting
When reporting performance to an investor, portfolio managers must present the Extended Internal Rate of Return (XIRR) for each Investment Approach, accompanied by the minimum, maximum and median XIRR return generated across all investors.
Annual Audit Requirement
Performance Audit Mandate
Previously, there was no requirement of performance audit. Now, audit will have to be specifically performed and submitted to SEBI.
Verification
The TWRR calculation and performance reporting must be verified as part of the annual audit under Regulation 30 of the PM Regulations.
Timeline
PMS players are required to conduct a performance audit annually and submit a report within 60 days after the end of a financial year.
Expert Legal Guidance
Anuj Desai & Associates provides expert legal advisory services on PMS performance reporting and TWRR compliance. Our securities law experts help portfolio managers implement compliant TWRR calculations, prepare performance reports, and ensure regulatory compliance. Contact us for guidance on TWRR and other regulatory matters.