The Modified Dietz method is a way to measure a portfolio’s historical (or ex-post) return. The result of the calculation is expressed as a percentage return over the holding period. Modified Dietz is considered to be an accurate reflection of an individual’s personal rate of return from holding an investment and is sometimes referred to as the modified internal rate of return (MIRR). The approach, which is based on a weighted calculation of the portfolio’s cash flows, takes into account:
- the market value of the holdings at the beginning of a period;
- its market value at the end of the period;
- all cash flows during the period (these could be contributions, withdrawals, or fees for example);
- and the length of time that each cash flow event was held in the portfolio or account.
The method assumes that there is a constant rate of return over a specified period of time, and is designed to exclude external factors that might otherwise affect the results. Modified Dietz is increasingly used by investment companies in reporting results to clients. It is considered to be a step forward in improving the reporting of investment portfolio performance.
The approach is named after Peter O. Dietz. Dietz was an academic and author of a number of influential works, during the 1960s, which looked at the measurement of returns from pension fund investments. His original aim was to find a quicker way of calculating an internal rate of return (IRR). With modern computing power, it is relatively simple to calculate an IRR today. However, at the time that Dietz was writing, IRR calculations relied on computers that were very limited by today’s standards. These were also expensive and therefore less widely available.
The Modified Dietz return is calculated by dividing the gain or loss in value of the portfolio, net of external flows, by the average capital in the portfolio over measurement period. The average capital weights individual cash flows by the length of time between those cash flows and the end of the measurement period. Consequently, flows that occur towards the beginning of the measurement period have a higher weight than flows occurring towards the end.