What is the ‘Modified Dietz Method’
The Modified Dietz Method is a mathematical technique to evaluate a portfolio’s return based on a weighted calculation of its cash flow. The Modified Dietz Method takes into account the timing of cash flows and assumes that there is a constant rate of return over a specified period of time. The Modified Dietz Method is more accurate than the Simple Dietz Method, which assumes that all cash flows come from the middle of the period of time being evaluated.
The Modified Dietz Method is a common return calculation used in the investment management industry. Industry watchdogs and investors are increasingly seeking greater transparency into how investment returns are calculated and reported. The Modified Dietz Method is widely recognized as a good step toward improved investment portfolio attribution reporting.
BREAKING DOWN ‘Modified Dietz Method’
The Modified Dietz Method is a dollar-weighted analysis of a portfolio’s return. It is a more accurate way to measure the return on a portfolio than a simple geometric return method, but can run into problems during periods of heavy volatility or if there are multiple cash flows within a particular period.
The Modified Dietz Method at times is also called the modified internal rate of return (MIRR), which is a popular return metric used in capital budgeting decisions. This approach to return calculation is similar to the dollar-weighted return method but has the advantage of not requiring a solver to the find the exact rate of return.
The method is named after Peter O. Dietz, whose original idea was to find a quicker, less computer-intensive way of calculating an IRR. Which at the time, required an iterative approach with slow computers by today’s standards.
Today, with the advance of technology, most systems can calculate a true time-weighted return by calculating a daily return and geometrically linking to get a monthly, quarterly, annual or any other period return. However, the Modified Dietz Method remains useful because of its performance attribution calculation benefits unavailable with time-weighted calculation methods.
This method for return calculation is a signature of modern portfolio management. It is one of the methodologies of calculating returns recommended by the Investment Performance Council (IPC) as part of their Global Investment Performance Standards (GIPS). The GIPS are intended to provide consistency to the way portfolio returns are calculated internationally.
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