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How to tell if your portfolio is really performing

by | Mar 12, 2014 | NEWSPRINT

Make sure you’re using the right investment benchmark

If you have an investment portfolio, you’ve probably seen statements from your advisor or broker showing how your portfolio has performed over the past month, quarter, and year. I’ve frequently been asked why portfolio performance doesn’t always “match” some popular index, like the S&P/TSX Composite or the S&P 500 Composite. This question often causes friction between financial advisors and their clients. That’s why, with new clients, I always try to explain the crucial concept of “benchmarking” right off the bat. Here’s why it’s important.

Investment portfolios, like advisors and managers, come in many different varieties, with many different kinds of objectives. Some are conservative, low-risk, and ultra-defensive. Others are aggressive and growth-oriented with higher risk. Investment experts long ago realized that you can go badly off track if you attempt to apply the same standard of performance to all types of portfolios. Instead, the best way to value investment performance is to use a benchmark that is a credible independent standard against which the performance for your specific type of portfolio can be evaluated.

Setting the (right) standard

A benchmark is important from a couple of perspectives. It provides a basis to compare how your portfolio is doing against a passive alternative, and it provides a gauge to measure the performance of your portfolio as a whole, not just the individual securities within the portfolio.

A defensive balanced portfolio, for example, which includes both fixed-income and equity holdings, will necessarily perform differently than an aggressive all-equity portfolio. For example, the iShares Balanced Income CorePortfolio Fund (TSX: CBD) posted a 1-year return of 5.51% to Feb. 28, 2014. The iShares S&P/TSX Capped Composite Index Fund (TSX: XIC) returned 14.05% in the same period. The balanced fund consists of both equity and fixed-income holdings, and posted a 3-year standard deviation (a measure of volatility, or risk) of 1.39. The equity fund simply tracks the S&P/TSX Composite Index, and showed a 3-year standard deviation of 2.92. In other words, while the all-equity fund produced a superior 1-year return, it was more than twice as volatile as the balanced fund.

Don’t compare apples with oranges

You can see the difficulty in applying the same standard of performance measurement to these two funds. A balanced fund simply will not perform like an equity fund, and it’s a mistake to expect it to. You get a more honest picture of your portfolio performance when you compare it with a benchmark that is representative of the type of portfolio and objectives you actually hold. In other words, you want an apples-to-apples comparison.

Of course, this opens up another problem entirely: What constitutes a good benchmark against which to compare performance of your portfolio? There are countless indexes now available to measure almost every conceivable kind of portfolio. Some managers even create their own hybrid indexes if they find nothing in the marketplace that provides a suitable benchmark.

Characteristics of a good benchmark

A good benchmark has five essential characteristics. 1) It’s unambiguous in that the components are clearly specified. 2) It is appropriate or representative in that it is consistent with your portfolio objectives. 3) It must be measurable and be established frequently. 4) It must be current and based on marketable securities. 5) And lastly, it must be investable in that it can be replicated and the components can be purchased separately.

Some of the most widely watched benchmarks for Canadian investors include the PC Analytics DEX Bond Universe Total Return Index (fixed income), the S&P/TSX Composite Total Return Index (Canadian equities), the S&P 500 Composite Total Return Index in Canadian dollars (US equities), and the MSCI EAFE Total Return Index in Canadian dollars (international equities). The FPX Indexes, published by the Financial Post since 1998, are an interesting and useful set of Canadian indexes that try to reflect average income, balanced, growth portfolios.

When measuring performance, be sure to compare apples to apples for a fair comparison. Every portfolio manager and financial advisor will be using some type of benchmark for their clients’ portfolios. It’s important to know what that benchmark is. If you’re unsure, ask your advisor.

© 2023 by Robyn K. Thompson. All rights reserved. Reproduction without permission is prohibited. This article is for information only and is not intended as personal investment or financial advice.

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