Compared to what? Part 3: A relevant benchmark
In Part 2 of our series on assessing investment performance, we looked at how the level of risk assumed in a portfolio should be an important consideration in evaluating the quality of your return.
In this post, we’ll look at the third and final key consideration in understanding how your investments performed in 2017: understanding how your investment return compared to a relevant benchmark.
At Newport, we aim to earn investment returns equal to or better than the relevant benchmark over a full market cycle but with significantly less risk than the benchmark.
If you compare your investment return to a benchmark, be careful that it is a comparable and a relevant one i.e. a stock portfolio should be measured against the comparable stock index. For example, a portfolio comprised primarily of equities should be compared to an equity index and not a balanced benchmark . We have seen examples of selective, inappropriate benchmarks used by some manager. For example, an equity portfolio containing 40% U.S. stocks would appeared to have outperformed when compared only to the S&P/TSX (Canadian) benchmark, which did not do as well as the U.S. S&P 500 benchmark last year. If unclear about what the benchmarks are for your portfolio, ask your financial advisor/money manager for details.
Also bear in mind that you can’t actually buy a benchmark. The closest approximation is an Exchange Traded Fund (ETF), which mirrors a given index. ETFs have fees. Therefore, to compare apples to apples, you should at least theoretically deduct an amount for fees (e.g. 30-70 bps) from the benchmark performance for a true comparison to your portfolio.
In 2017, the S&P/TSX returned 9.10% and while the U.S. market (S&P 500) did much better, returning 21.83%, the Loonie’s sharp rise was a drag on its performance for Canadian investors lowering it to 13.84%. Did your portfolio earn outsized returns compared to its benchmark last year? If so, we suggest that you dig deeper and find out the source of the outperformance, likewise if your portfolio underperformed.
There are important questions to be answered. Where did your performance come from? Was it from a handful of stocks? Is it repeatable? Answers to these questions will help you determine if the portfolio’s risk is appropriate for you. If it isn’t, or you aren’t sure, a second opinion may be in order. We frequently provide this service for prospective clients and many are surprised at the results.