Last Updated on 2020-02-24 by Admin
Holding Period Return (HPR)
Holding Period Return (HPR) is a measure of the total return on an investment over a specific period of time, regardless of whether the investment is held for a short or long duration. It takes into account both income earned from the investment (such as dividends or interest) and capital gains or losses due to price changes during the holding period.
HPR is particularly useful for assessing the performance of an investment over a discrete time period, like a year, month, or any other specified time frame. It’s often used in investment analysis to compare the performance of different assets, portfolios, or investment strategies.
Formula for Holding Period Return (HPR)
The basic formula for calculating the Holding Period Return (HPR) is:
Where:
- Final Price: The final price of the investment at the end of the holding period.
- Original Price: The initial value of the investment at the start of the holding period.
- Income: Any income received during the holding period (such as dividends, interest, or other distributions).
Understanding the Components
- Original Price: This is the price at which the asset or security is initially purchased. For example, if you buy a stock at $100 per share, the beginning value is $100.
- Final Price: This is the price of the investment at the end of the holding period. For instance, if the stock price has risen to $120 by the end of the year, the ending value would be $120.
- Income: This includes any dividends, interest, or other distributions received during the holding period. For example, if the stock paid $5 in dividends over the year, this income would be added to the formula.
Examples of Holding Period Return (HPR)
Example 1: Stock Investment with Dividends
Suppose an investor buys 100 shares of a stock for $50 per share at the beginning of the year. During the year, the stock pays $2 per share in dividends, and by the end of the year, the stock price rises to $60 per share.
- Beginning Value = $50 × 100 shares = $5,000
- Ending Value = $60 × 100 shares = $6,000
- Income = $2 × 100 shares = $200 (dividends received)
Now, plug the values into the HPR formula:
In this case, the Holding Period Return is 24%, meaning the investor achieved a 24% return on the investment over the year, considering both capital appreciation and dividends.
Example 2: Bond Investment with Interest
Let’s assume an investor purchases a bond for $1,000. Over the next year, the bond pays $50 in interest (coupon payment), and the price of the bond rises to $1,050.
- Beginning Value = $1,000
- Ending Value = $1,050
- Income = $50 (interest received)
Now, apply the HPR formula:
In this case, the Holding Period Return is 10%.
Significance and Uses of Holding Period Return
The Holding Period Return is widely used for several reasons:
- Performance Evaluation: HPR helps investors assess how well their investments have performed over a given period, taking into account both price appreciation and income received.
- Comparison of Investments: Since HPR can be calculated for various types of investments (stocks, bonds, real estate, etc.), it allows for a direct comparison between different assets or portfolios to evaluate which has provided the better return over the same period.
- Risk-Adjusted Comparison: HPR can be used in conjunction with risk measures (like standard deviation or beta) to evaluate returns relative to the level of risk taken. This helps investors in decision-making by comparing not only returns but also the associated risks.
- Annualizing the Return: While HPR calculates the return for a specific holding period, it can be annualized to allow comparison between investments held for different lengths of time. This is particularly useful if investments are held for periods shorter or longer than one year.
Annualizing Holding Period Return (for non-annual periods)
When an investment is held for less than or more than a year, it is common to annualize the holding period return to make it comparable to annualized returns from other investments. The annualization process adjusts the return to reflect a full year, assuming the investment’s performance over the holding period would continue at the same rate.
To annualize a return, you can use the following formula:
Where:
- HPR is the holding period return for the investment.
- n is the number of years (or fractions of a year) the investment was held.
Example: Annualizing a Six-Month Return
Let’s say an investor has a holding period return of 10% for an investment held for 6 months. To annualize the return, use the formula:
In this example, the annualized holding period return is 21%, assuming the same performance would continue for the full year.
Limitations of Holding Period Return
While HPR is a useful measure, it has some limitations:
- Does Not Account for Compounding: If the investment involves reinvestment of income (such as dividends or interest), HPR does not account for the compounding effect unless the income is reinvested during the holding period.
- Non-Standardized Time Frame: Since the holding period can vary significantly (from days to years), HPR doesn’t provide a standardized way to compare investments over different time periods unless the return is annualized.
- Does Not Factor in Risk: HPR focuses on the return of an investment but does not directly measure the risk taken to achieve that return. It can be misleading when comparing investments with different risk profiles.
- Excludes Transaction Costs: The formula assumes no transaction costs (such as brokerage fees), taxes, or other expenses, which could affect the net return.
Real-World Application of HPR
HPR is often used in the following scenarios:
- Equity and Fixed Income Investment Performance: Investors and portfolio managers use HPR to assess the return on stocks, bonds, or mutual funds over a specific period, including dividends, interest, and capital gains.
- Real Estate Investments: HPR can be used to calculate the total return on real estate investments, considering both rental income and changes in property value.
- Private Equity: HPR is often applied to investments in private equity, where investors want to evaluate the overall return over the period they held the investment, factoring in distributions and changes in value.
Conclusion
The Holding Period Return (HPR) is an essential metric for measuring the total return of an investment over a specific period. By including both income and capital gains or losses, HPR provides a comprehensive picture of an investment’s performance. While HPR is a simple and effective tool for performance assessment, investors should be aware of its limitations, including its lack of consideration for compounding, risk, and transaction costs. Annualizing the return can make it more comparable to other investments held over different periods. HPR remains a fundamental calculation for comparing the performance of various assets and for evaluating the success of investment strategies.
Formula
$$\begin{aligned} HPR\; &= \left [ Final\;Price\;-\;Original\;Price\;+\;Income \over Original\;Price \right ] \\\\ &= \;\left [ Capital\;Gain\;+\;Dividends \over Original\;Price \right ] \end{aligned}$$
Holding Period Return (HPR)
