The Original Approach What I was looking at was to what extent the return could be broken down into a sustainable component plus “froth”.
Using the same figures as before (see origins), we had 20 % pa followed by 10 % pa. Over the whole interval, we therefore had 5 % pa (ignoring compounding).
The original 20 % pa can be reexpressed as 5 % pa plus 15 % pa “froth” which would eventually disappear. Similarly, the 10 % pa can be reexpressed as 5 % pa minus 15 % pa “froth”.
With perfect hindsight, we can easily assess the “froth” term. It would be more useful to be able to estimate the “froth” in advance. In fact, it turns out that, over some tine periods but not all, the DVR can be used on a continuing basis with reasonable accuracy.
My Revised Approach Although I still think the sustainability element is important, I have realised that trustees and their advisors still have market values in mind. The concentration upon market values in actuarial valuations of definedbenefits pension schemes in the UK since 2000, even more so since 2006, makes that even more likely. So I am now concentrating upon how the cumulative DVR tracks the ultimate cumulative MVR. Let’s look at an example (definitions are here).
