Explanation

The time-weighted return (TWR) measures the compound growth rate of $1 initially invested in the portfolio over a stated period. It is calculated by taking the geometric mean of the holding period returns for each sub-period, which eliminates the effect of cash inflows and outflows.

Key points:

• Time-weighted return is unaffected by cash flows - it reflects only the investment manager's performance
• Money-weighted return (also called internal rate of return or IRR) is affected by the timing and size of cash flows

When funds are contributed just before favorable performance:

1. The money-weighted return will be elevated because the new money participates in the good performance
2. The time-weighted return remains unchanged because it's calculated independently of cash flows

Why option B is correct:

• The money-weighted return gives more weight to periods when more money is invested
• Adding funds before good performance means more money earns the high returns, boosting the overall IRR
• This creates a positive bias in the money-weighted return

Why option A is incorrect:

• Money-weighted returns would be depressed if funds were added before poor performance
• Adding funds before good performance has the opposite effect

Why option C is incorrect:

• Time-weighted returns are not affected by cash flows at all
• They measure the manager's skill independently of investor contributions/withdrawals

Practical implication:

• Time-weighted return is preferred for evaluating investment manager performance
• Money-weighted return is better for measuring investor's actual experience
• The distortion described is why CFA Institute recommends TWR for performance reporting