September 2019

Hi,

ia) Cashflows into the fund alter the value of units but not the unit price. So the simplest way to calculate the TWRR is simply to look at the price changes in the units. Otherwise you could take a more "core-reading formula" approach to the question. For this to work we need to work out the fund value at each time point:

At time 0 we have £108m invested in the units at £1 each. At time 1 the fund value drops to £97.2m (108*0.9) at which point £5m is invested which purchase 5m/0.9 = 5.5556m units. At time 2 we have 113.5556m units worth £1.14 each which gives a fund value of £129.4534m. The further investment of £2m buys a further 1.7544m units. Then at time 3 we have 115.3099m units with a fund value of £153.3622m. The core-reading formula then calculates the TWRR as:

(1+i)^3 = (97.2/108)*(129.4534/102.2)*(153.3622/131.4534) = 1.33

as with the unit price only method.

ib) That's correct. E.g a single investment made on 31/12/2017 for a period of one year would have done better invested in A rather than B with a return of 16.7% rather than 6.3% over that period. By considering returns over the whole period we don't necessarily appreciate which investment strategy over that 3 years would have been best ie there may have been times at which we would have performed better in A than B as above.

ii) I think this is solved with my answer to part (i)(a) as well. It's all about the fund value in this case, because the value of the fund at the end is not 133 but 153.36 because the cashflows over the year have purchased extra units and so we've invested more than £100m.

iii) The pattern of the cashflows shows greater investment being made in fund A rather than B early in the period. With fund A's returns being best in the second and third years the pension scheme benefits from investing the money earlier rather than later. On the other hand fund B had it's best returns in the first year, but by investing later on in the 3 year period the trustees do not benefit from the higher return. As MWRR takes into account the timing of the cashflows, and the returns they have therefore benefited from, the MWRR on A is higher than B.

I don't think you've made any real fundamental mistakes here or if you've had it's the same one. Take a look at this question again with a fund value in mind (number of units * unit price) and I think it will start to make more sense.

Hope this helps
Joe

 

Thanks for flagging on Q3. I suspect the examiners have gone a little too strong on the wording here. With SP5 it's very dangerous to say a certain fund or investment type does not exist because there are endless possibilities in the real world. I think we can probably agree that there seems little practical use in tracking the Dow Jones, but it wouldn't necessarily stop people doing so. I'd have thought the practicalities of having to rebalance the constituents constantly would be enough to put anyone off, but clearly not.

I think the wording of our ASET is a little softer on this but I'll take this away nonetheless.

Thanks again
Joe