During our Fundamentals of Investment Performance class, when we get to the discussion of time- versus money-weighting, a question arises as to why firms continue to exclusively employ time-weighting, when it’s quite clear that there’s a major role for money-weighting. I typically use a scene from the 1972 move, The Poseidon Adventure, as a metaphor for one possible reason.
The scene occurs shortly after the boat has done a “180,” and the major characters (Gene Hackman, Ernest Borgnine, Red Buttons, Shellly Winters, etc.) are gathered together along a corridor. Hackman (Rev. Frank Scott) tells them they need to go in the direction that is the complete opposite of where everyone else is running. Borgnine’s character (Mike Rogo) challenges him, asking what makes him so sure since everyone else is rushing the other way. Hackman insists that the others are heading to their deaths because that direction won’t provide a way out.
Now, if you use the wrong return formula surely death won’t follow. However, our natural tendency to want to “go with the crowd” can cause us to miss out on doing things a better way. Avoid the “Poseidon Effect” and take advantage of what money-weighting has to offer.