What is the Modified Dietz Method?

The modified Dietz Method is a preferred calculation method used in the investment management industry. It is well known as a good step toward improved investment portfolio attribution reporting. This method functions as a formula for measuring a portfolio's return based on a weighted calculation of its cash flow. It accounts for the duration of cash flows and specifies that the rate of returns over a specific time frame is constant. The modified Dietz method is more transparent and precise in calculating investment returns. It is quite different and more precise than the Simple Dietz Method where all cash flow is determined to come from the period of time evaluated.

How Does the Modified Dietz Method Work?

The Modified Dietz Method was developed by Peter O. Dietz. It is a precise method for calculating the return on a portfolio compared to the simple geometric return method. It was developed by Peter to ease the difficulty of calculating an internal rate of return on slow computers. It aimed at providing an effective, quicker and accurate method in calculating IRR. The Modified Dietz Method 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 aimed at maintaining consistency in the way portfolio returns are calculated across the international organization. As an improvement on these slow computers, modern-day technology has provided fast systems that are capable of calculating a true time-weighted return by calculating a daily return and geometrically linking to obtain a monthly, quarterly, annual or any other period return. However, the Modified Dietz Method remains quite significant because of its performance attribution calculation benefits. This is unavailable with the time-weighted calculation methods. The primary disadvantage is that: the modified Dietz Method can encounter difficulties if there are many cash flows within a stipulated period. This method is also referred to as the Modified Internal Rate of Return (MIRR) because of the similar objective of calculating the internal rate of return. While the Modified Dietz Method is precise and accurate, the MIRR does not need a solver to find the precise rate of return. The MIRR is specifically used in making capital budgeting decisions.