Portfolio Performance Evaluation – TWRR vs MWRR | Risk-Adjusted Return | SEBI Reporting

Portfolio performance evaluation is the measurement of what a portfolio earned and what risk was taken to earn it. The recurring failure in practice is to look at the return alone. A manager who takes a portfolio from ₹100 to ₹50 and back to ₹100 has produced an average annual return of 25 per cent and made the investor nothing. Proper evaluation therefore runs in three stages: measure the return on the right basis, measure the risk, then combine the two and compare the result against a benchmark and a peer group.

Table of Contents

1. What is Portfolio Performance Evaluation?
2. Rate of Return Measures
3. TWRR versus MWRR: Why the Same Portfolio Gives Two Answers
4. Gross, Net, Pre-tax and Cash Drag
5. Risk Measures
6. The Five Risk-Adjusted Return Measures
7. Benchmarking and Peer Group Analysis
8. Performance Attribution
9. What a PMS Client Must Be Sent
10. Frequently Asked Questions

Check out NISM X Taxmann's Portfolio Management Services (PMS) Distributors, the official NISM workbook for the NISM-Series-XXI-A certification, in its September 2025 Workbook Version. Chapter 10 works the return, risk and risk-adjusted measures in this article from numerical examples, including the SEBI illustration of a time-weighted rate of return across contributions and withdrawals.

1. What is Portfolio Performance Evaluation?

Performance evaluation recognises both the return an investment earned and the risk taken to earn it. The human tendency runs the other way, towards the return alone, which is why the discipline exists.

Rate of return is the single most important statistic in the exercise, and it has many possible definitions. There is one appropriate definition for each purpose. The practical instruction is to be clear about why the performance is being measured before choosing which return to compute.

2. Rate of Return Measures

2.1 Holding period return

The holding period return, also called total return or point-to-point return, is the income generated by an investment plus the change in its value, over the beginning value, expressed as a percentage per annum.

A portfolio worth ₹1,00,000 on 1 April 2018 and ₹1,20,000 on 31 March 2019 has returned 20 per cent. Add ₹5,000 of dividend and interest received in the same period and the return becomes 25 per cent, because income enters the numerator. The measure assumes all income distributions arrive at the end of the year. Despite that limitation it remains the accepted starting point for any performance measurement exercise.

2.2 Arithmetic mean against geometric mean

Take two portfolios, each starting at ₹1,00,000. The first returns minus 50 per cent in year one and plus 100 per cent in year two. The second returns 10 per cent in each year.

The first ends at ₹1,00,000, exactly where it began, on an arithmetic average of 25 per cent a year. The second ends at ₹1,21,000, on an arithmetic average of 10 per cent a year. The portfolio with the lower average return made the investor money and the one with the higher average did not.

The geometric mean settles the question. It is the rate at which the sum invested at the start accumulates to the sum at the end through compounding, and it depends only on the initial and final values, not on the path between them. For the first portfolio the geometric return is zero. For the second it is 10 per cent.

Over a single year the two are identical. Over longer periods the geometric return is always lower than the arithmetic return, except where every yearly return is the same. A manager can always raise the arithmetic average by taking more risk. Geometric return is the only sound basis for comparing long-term accumulation.

3. TWRR versus MWRR: Why the Same Portfolio Gives Two Answers

Money weighted rate of return is the internal rate of return on the investor’s actual cash flows. Time weighted rate of return removes the effect of those cash flows and measures the manager. The two answer different questions, and the gap between them can be very wide.

Take a portfolio producing these annual holding period returns:

Year	Holding period return
2015	-5.00%
2016	-15.20%
2017	8.10%
2018	30.75%
2019	17.65%

An investor contributes ₹75,000 in total, at the beginning of each year, rising from ₹5,000 in 2015 to ₹25,000 in 2019. The portfolio ends 2019 at ₹1,05,920.31. Discounting that terminal value against the contributions gives an internal rate of return of 15.15 per cent. That is the MWRR.

Now reverse the order of the contributions. Same total of ₹75,000, same five annual returns, but ₹25,000 goes in first and ₹5,000 last. The portfolio ends at ₹1,07,900.97 and the MWRR falls to 10.21 per cent. Nothing about the manager changed. Only the timing of the investor’s money did.

TWRR strips that out. The GIPS glossary defines it as a calculation that computes period by period returns, removes the effects of external cash flows, which are generally client driven, and best reflects the manager’s ability to run assets to a stated strategy. The portfolio is valued every time there is an external cash flow, a return is computed for each sub-period, and the sub-period returns are chain linked.

For the five annual returns above, the wealth relatives multiply to 1.3396, so one rupee became ₹1.3396 over five years. Annualised, the TWRR is 6.02 per cent. Three numbers, one portfolio.

The SEBI (Portfolio Managers) Regulations, 2020 require a discretionary portfolio manager to disclose performance using time weighted rate of return for the immediately preceding three years. SEBI’s own worked illustration, from its FAQs of October 2020, runs like this. An account is funded on 1 January 2019 with ₹50,00,000. On 1 March 2019 the client adds ₹20,00,000; the market value on 28 February 2019 was ₹49,00,000. On 1 October 2019 the client withdraws ₹10,00,000; the market value on 30 September 2019 was ₹75,00,000. The closing value on 31 December 2019 is ₹70,00,000.

Sub-period	Sub-period return	1 + return
1 Jan 2019 to 28 Feb 2019	(49,00,000 − 50,00,000) ÷ 50,00,000 = −2.00%	0.98
1 Mar 2019 to 30 Sep 2019	(75,00,000 − 49,00,000 − 20,00,000) ÷ (49,00,000 + 20,00,000) = 8.69%	1.08
1 Oct 2019 to 31 Dec 2019	(70,00,000 − 75,00,000 + 10,00,000) ÷ (75,00,000 − 10,00,000) = 7.69%	1.07
TWRR	((0.98 × 1.08 × 1.07) − 1) × 100 = 14.71%

A distributor who can walk a client through that table has answered the most common complaint in the business, which is that the client’s own return does not match the number in the marketing material.

4. Gross, Net, Pre-tax and Cash Drag

4.1 Gross against net

Gross return is the total return before any fees, expenses or commissions. Net return is what the investor actually keeps. The workbook runs a full example on a ₹100 lakh portfolio over one year, earning 20 per cent, with a 10 per cent hurdle rate, other expenses at 0.50 per cent of gross value, a fixed management fee of 1.5 per cent charged on the average of capital contribution and gross value, a performance fee of 20 per cent of profits over the hurdle without catch-up, an exit load of 2 per cent, and nil upfront and setup fees.

Line	Amount (₹)
Capital contribution	1,00,00,000
Gross value at end of year, after 20% profit	1,20,00,000
Less other expenses at 0.50% of gross value	60,000
Less fixed management fee at 1.50% of the average of ₹1,00,00,000 and ₹1,20,00,000	1,65,000
Required value at the 10% hurdle	1,10,00,000
Less performance fee at 20% of (₹1,17,75,000 − ₹1,10,00,000)	1,55,000
Less exit load at 2%	2,32,400
Total charges	6,12,400
Net value of the portfolio	1,13,87,600

Gross return 20 per cent. Net return 13.88 per cent. The 6.12 percentage points in between are the whole reason the cost architecture is a subject in its own right.

4.2 Pre-tax against post-tax

Performance is communicated pre-tax, because investors sit in different brackets and a common basis is needed for comparison. The investor or the adviser converts it. Post-tax return equals pre-tax return multiplied by one minus the tax rate. A 5 per cent pre-tax return with capital gains tax at 15 per cent is a 4.25 per cent post-tax return. What matters to the investor is the second figure.

4.3 Cash drag

A manager may not invest the entire capital contribution, for a variety of reasons. Return has to be computed on the whole of it anyway, and managers have been observed doing otherwise.

An investor puts ₹100 lakh into an equity portfolio. The manager invests ₹75 lakh in equities and leaves ₹25 lakh in liquid funds. The equity exposure earns ₹7.5 lakh and the liquid funds return 4 per cent. Reported on the invested amount alone, the return is 10 per cent. Adjusted for the drag that cash exerts, it is 8.5 per cent on the full ₹100 lakh. The second number is the one the investor experienced.

4.4 Alpha and beta

Under the Capital Asset Pricing Model, required return equals the risk free rate plus beta times the market risk premium. Alpha is the return above that.

A portfolio returns 25 per cent. The benchmark returns 15 per cent, the portfolio beta is 1.5 and the treasury bond yield is 5 per cent. The return decomposes into a risk free component of 5 per cent, a beta return of 1.5 × (15% − 5%) = 15 per cent, and an alpha return of 5 per cent. This is Jensen alpha. Some practitioners use alpha differently, to mean the excess over the benchmark, which here would be 10 per cent. Beta return rewards the bearing of market risk; alpha return rewards the bearing of non-market risk.

5. Risk Measures

Risk in investment terms has two definitions. Total risk is the variability in expected return, measured by variance and standard deviation. Downside risk covers only losses or worse-than-expected outcomes, measured by semi-variance and semi-standard deviation.

Standard deviation quantifies how far returns fluctuate around their average, and a higher value means higher risk. It is used more than any other measure to describe the risk of a security or a portfolio. One of its strengths is that it works across the board: the calculation is identical for a portfolio of bonds, a portfolio of growth stocks or anything else. A portfolio with a monthly standard deviation of 3.27 per cent and an expected return of 2 per cent has a 66.7 per cent probability of returning between minus 1.27 per cent and 5.27 per cent, a 95 per cent probability of falling within two standard deviations, and a 99 per cent probability of falling within three.

Portfolio risk is not the weighted average of the individual standard deviations. It depends on the weights, the individual standard deviations and, above all, the correlation across the investments. Poorer the correlation, lower the portfolio risk. The exception is a set of investments with perfect positive correlation, which does not occur in practice.

Beta measures systematic risk, the risk from common factors such as interest rates, exchange rates and commodity prices, which cannot be diversified away though it can be hedged. Beta relates the return of a portfolio to the return on a market index and needs two price series over a reasonably long period, typically three to five years. Portfolio beta is the weighted average of the individual betas: a stock with beta 1.2 at 60 per cent and one with beta 1.1 at 40 per cent give a portfolio beta of 1.16. Above one is more volatile than the index; below one, less.

Tracking error is the standard deviation of the difference between the portfolio’s total return and the target benchmark’s. Lower tracking error means returns closer to the index. It is always calculated against the Total Returns Index, which includes dividends, and it arises mainly from a mismatch between the risk profile of the portfolio and that of the benchmark.

6. The Five Risk-Adjusted Return Measures

Differential return may be nothing more than differential risk exposure, so return has to be adjusted for risk. Five measures do that, and they are not interchangeable.

Measure	Formula	Risk in the denominator	Use it when
Sharpe ratio	(Rp − Rf) ÷ standard deviation	Total risk	The investor’s wealth as a whole is not adequately diversified
Treynor ratio	(Rp − Rf) ÷ beta	Systematic risk	The portfolio sits alongside other actively managed portfolios in a diversified holding
Sortino ratio	(Rp − Rf) ÷ semi-standard deviation	Downside risk	The investor treats risk as the chance of losing money rather than as uncertainty
Information ratio	(Rp − Rb) ÷ standard deviation of (Rp − Rb)	Active risk, which is tracking error	You need to know whether an observed alpha came from skill or from chance
M-squared	Return of the portfolio levered or de-levered to the market’s volatility, compared with the market return	Volatility matched to the market	You want the answer expressed in percentage points rather than as a ratio

Worked, with the same portfolio: an annualised return of 10.50 per cent, an annualised standard deviation of 6.50 per cent and a risk free rate of 5.50 per cent give a Sharpe ratio of 0.7692. The portfolio generated 0.7692 percentage points of return above the risk free rate for each percentage point of standard deviation. If the beta of that portfolio is exactly 1, the Treynor ratio is 0.05, meaning 0.05 percentage points of excess return for each unit of systematic risk.

Sharpe and Treynor rank a fully diversified portfolio identically, because total risk and systematic risk converge. Any difference in the two rankings is a statement about how well the portfolio is diversified, since Treynor ignores unsystematic risk.

M-squared works differently. Modigliani and Modigliani adjusted the portfolio’s risk to match the market’s, then compared returns directly. A portfolio returning 35 per cent with a standard deviation of 42 per cent, against a market returning 28 per cent with a standard deviation of 30 per cent and a treasury bill rate of 6 per cent, is de-levered to 30 ÷ 42 = 0.714 in the portfolio and 0.286 in treasury bills. The hypothetical portfolio returns 26.7 per cent. That is 1.3 percentage points below the market, so the managed portfolio underperformed, in spite of the headline 35 per cent.

Running these ratios across a client’s holdings is arithmetic rather than judgement, and the calculators on Taxmann’s Tools handle the mechanical part.

7. Benchmarking and Peer Group Analysis

Performance evaluation is relative. A measured return means nothing until it is set against a suitable benchmark or a comparable group of managers.

A good benchmark satisfies five criteria:

• The identity of its constituents and their weights are clearly defined
• It is investable, so that passive exposure to it is possible
• It is consistent with the portfolio’s investment approach, so a value portfolio is measured against a value benchmark
• It has the same risk and return profile as the portfolio
• Its own performance is measurable

Where market indices cannot meet those tests, a customised benchmark is built from the manager’s own investment universe. It satisfies the criteria, and it costs considerably more to construct and maintain than a licence on a market index.

Peer group analysis runs alongside. The median portfolio, or the universe of managers following a similar approach, becomes the yardstick. Tracking firms maintain databases that rank portfolios of similar characteristics on a risk-adjusted measure.

8. Performance Attribution

Attribution is the second phase of evaluation. Several approaches exist; the framework put forward by Fama remains dominant.

The common theme is to split return into two components, the part driven by the benchmark and the differential, then to identify where the differential came from and whether it reflects the manager’s skill or a random factor. Two sources account for most of it.

Allocation. Overweighting a sector that outperformed the benchmark, or underweighting one that lagged it.

Selection. Picking securities that did better than the benchmark within a segment, or avoiding benchmark securities that did worse. The selection effect is weighted by the manager’s actual portfolio weights, because that is the proportion in which money was actually committed.

A third source appears in any portfolio holding foreign currency assets. An Indian investor puts ₹50 lakh into a US equity fund at ₹70 to the dollar, which buys USD 71,428.57. The fund returns 15 per cent, taking the holding to USD 82,142.86. Over the same period the rupee appreciates to 65. Converted back, the holding is worth ₹53,39,285.62, a return of 6.79 per cent rather than 15 per cent. Currency movement can enhance a return or remove most of it.

9. What a PMS Client Must Be Sent

Reporting is not left to the manager’s discretion. Under the SEBI Portfolio Managers Regulations, a portfolio manager must furnish a report to the client as agreed in the contract, at intervals not exceeding three months, and whenever the client asks. Seven items are prescribed:

1. The composition and value of the portfolio, with a description of the securities and goods, the number of securities, the value of each holding, units and value of goods, cash balance, and the aggregate value as on the date of the report
2. Transactions during the period, with dates and details of purchases and sales
3. Beneficial interest received in the period as interest, dividend, bonus shares or rights shares
4. Expenses incurred in managing the portfolio
5. Risks foreseen by the portfolio manager, and risks relating to the securities recommended for investment or disinvestment
6. Any default in payment of coupons or other payments on an underlying debt security, and any downgrade to default rating
7. Details of the commission paid to distributors for that particular client

The seventh item is the one distributors should read twice. The commission a distributor earns on a particular client is disclosed to that client, by the manager, in the periodic report.

On performance itself, SEBI Circular No. SEBI/HO/IMD/IMD-PoD/P/CIR/2022/172 dated 16 December 2022 sets out two separate obligations. When communicating, advertising, publishing or mentioning the performance of an investment approach, the manager presents the TWRR of that investment approach along with the trailing return of the selected benchmark. When reporting to an individual investor, the manager presents the Extended Internal Rate of Return for each investment approach the investor holds, accompanied by the minimum, maximum and median XIRR generated across all investors in that investment approach, with the TWRR of the investment approach and the trailing benchmark return shown separately.

A prescribed disclaimer accompanies the disclosure, recording that an investor’s own performance may differ from that of other investors and from the investment approach across all investors, because of the timing of inflows and outflows and because of differences in portfolio composition arising from restrictions and other constraints.

Valuation feeds the same reporting. APMI prescribes standardised valuation norms for portfolio managers, and debt and money market securities must be valued in accordance with them, using services obtained only from valuation agencies empanelled by APMI.

The current text of the Portfolio Managers Regulations and the circulars issued under them, with their amendment history, is available on Taxmann.com | Research. How the benchmark itself is selected and tagged is covered in the portfolio management process.

9.1 GIPS

The Global Investment Performance Standards govern how firms present performance results to prospective clients. They exist to make managers comparable regardless of geography, and to open a conversation with a prospective client about how a historical result was actually achieved. A firm claiming compliance must follow rules on both the calculation of returns and the way those returns are displayed. GIPS mandates the use of time weighted rate of return, which is the same basis the SEBI Portfolio Managers Regulations, 2020 prescribe for communicating past performance.

The GIPS Advertising Guidelines sit alongside the standards rather than replacing them, and apply only to firms that already meet the full standards firm-wide. An advertisement carrying a compliance claim must include eleven specified items, among them a description of the firm and of the strategy advertised, period-to-date composite results, one-, three- and five-year annualised composite returns or five years of annual returns, whether performance is gross or net of investment management fees, the appropriate composite benchmark total return for the same periods, the currency used, and a description of the use and extent of leverage and derivatives where these form an active part of the strategy.

10. Frequently Asked Questions

What is the difference between TWRR and MWRR?

MWRR is the internal rate of return on the investor’s actual cash flows and therefore depends on when money went in and out. TWRR values the portfolio at every external cash flow and chain links the sub-period returns, removing the effect of client-driven flows. MWRR measures the investor’s experience; TWRR measures the manager.

Which return must a PMS report to its clients?

Both. The manager presents the TWRR of the investment approach with the trailing return of the selected benchmark when communicating or advertising performance, and presents the XIRR for each investment approach the investor holds when reporting to that investor, along with the minimum, maximum and median XIRR across all investors in the approach. This follows SEBI Circular No. SEBI/HO/IMD/IMD-PoD/P/CIR/2022/172 dated 16 December 2022.

How often must a portfolio manager report to a client?

At intervals not exceeding three months, as agreed in the contract, and whenever the client requires it.

Which is better, the Sharpe ratio or the Treynor ratio?

Neither is better in the abstract. Sharpe divides excess return by total risk and suits an investor whose overall wealth is not well diversified. Treynor divides excess return by beta and suits an investor holding the portfolio alongside other actively managed portfolios. For a fully diversified portfolio the two give identical rankings.

What is the information ratio used for?

To test whether an observed alpha reflects skill or chance. It divides the active return, meaning the portfolio return less the benchmark return, by the active risk, which is the tracking error.

What is cash drag?

The effect of uninvested cash on portfolio return. If a manager invests ₹75 lakh of a ₹100 lakh contribution in equities and leaves ₹25 lakh in liquid funds, the return has to be computed on the full ₹100 lakh, not on the invested portion alone.

Is the distributor’s commission disclosed to the client?

Yes. Details of the commission paid to distributors for the particular client form one of the seven prescribed items in the periodic report the portfolio manager sends that client.

Every calculation in this article is worked line by line in NISM X Taxmann's Portfolio Management Services (PMS) Distributors, the official workbook for the NISM-Series-XXI-A certification. Every NISM certification workbook published by Taxmann is listed on Taxmann.com | Store.