Time-weighted and dollar-weighted investment returns are easily conflated and sometimes vastly different. Time-weighted returns are the performance of an investment, without consideration of the amount of money invested in the strategy. These are the headline published returns that appear in performance rankings and get fund managers hired and fired. Dollar-weighted returns measure the gains investors truly earned, based on the size and timing of their contributions and withdrawals and the current value of their investment.
In January 2024, spot bitcoin ETFs began trading in U.S. markets. These ETFs hold only bitcoin, which is a volatile virtual asset with no investment income. With no interest or dividends to obscure returns, these ETFs are a great case study to illustrate how much time- and dollar-weighted returns can diverge.
For dollar-weighted returns, the chart displays an estimate of the bitcoin ETF cost basis. The recent rally has pushed the bitcoin price back above the estimated bitcoin ETF cost basis. Comparing the bitcoin market prices against the ETF cost basis is a good proxy for the ETF investors’ dollar-weighted returns. While the ETFs’ cumulative published returns are 79% since inception, the average ETF investor’s return is only a little better than break-even.
New money tends to flow into investments with strong, published returns, often without adequate consideration of current prices. Higher interest rates, volatile energy markets, and surging AI-related investment have driven large moves in securities prices, producing many headline return outliers like 79% for the bitcoin ETFs. However, as the bitcoin ETFs show, chasing strong published returns can turn exceptional time-weighted returns into weak dollar-weighted ones. Investors who weigh trailing performance against price and valuation are likely to have the best dollar-weighted returns.