What is the main limitation of using the time-weighted rate of return for performance measurement?

Question: What is the main limitation of using the time-weighted rate of return for performance measurement?

Answer options:

• It is overly sensitive to significant cash flows into or out of the portfolio. ✅ It does not account for the timing or magnitude of cash flows, making it unsuitable for manager evaluation.
• It requires daily valuation of the portfolio, which can be costly.
• It is always higher than the money-weighted rate of return.

Correct answer: It does not account for the timing or magnitude of cash flows, making it unsuitable for manager evaluation.

Explanation: The time-weighted rate of return neutralizes the effect of cash inflows and outflows, making it suitable for evaluating the performance of an investment manager, as it reflects the manager's ability to pick securities and allocate assets. Its main limitation is that it does account for the timing or magnitude of cash flows, which can be useful for reflecting the investor's actual experience.