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IRR vs. TWR, or why can’t we all just get along By Jesse Reyes, QuartileOne, LLC
article IRR vs TWR.pdf
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After leaving graduate school so many years ago (at the risk of dating myself as this was
right before the advent of modern PC-based spreadsheets) I was convinced that the
most dangerous weapon in the hand of a newly minted MBA was the HP-12C calculator
with its nifty IRR/NPV function, which at the time was a real game changer. While the
tools financial analysts have at their disposal have progressed significantly, that fear
has evolved to really mean that the IRR is probably the most dangerous weapon in the
arsenal of the typical MBA.
I’ve been in the performance measurement and benchmarking business for over 20
years, during which the state of the performance analytics field has become increasingly
complex and academically esoteric. To many it has evolved into quasi-religions, each
one with priests, ideology and schools of thought feeding into a debate that is often
rancorous, vociferous and polarised.
The two schools that have evolved actually result from arguments which are probably
50 years old and revolve around the issue of IRRs (money weighted returns) and geometric
mean returns (time weighted returns).
I wish I could say I am totally agnostic in this debate, but I have probably been an IRR
apologist for some time (after all my first born daughter’s initials are I.R.R.). And I am
one of the inaugural members of a group of like-minded acolyte dedicated to all things
IRR and who meet several times a year to sort out the latest research on the topic. I do
however see the value of both measures and feel that the issue isn’t so much the ideology
but the appropriateness of their application.
If you google ‘IRR’ you usually get not only the exexpected ‘how to calculate’ entries, but
also lots of articles and links to white papers on how the IRR is bad and how it can be
fixed. Just about every year there is another paper that tries to modify the IRR to fix
some of these flaws and just in the last six months I have reviewed three different
approaches proposed to fix the issues with the allegedly schizophrenic IRR. But like a
bad relative, it may be that we must have to learn to accept and love the IRR and realise
that the flaws are inherent and can’t be fixed easily, but the measure can never be
abandoned to the streets – we just have to take care in how we use it.
I will provide a bit of background on the evolution of the issues. I cannot do justice in
such a short treatise to all the various methods/measures/modifications that have been
proposed and there is not enough room to go through all the mathematical intricacies that are inherent but I hope to provide a survey of the state of the world and how we
got here and see if I can provide a bit of guidance on navigation. I leave the reader to
other resources on the calculation and other metrics.
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