Episode 61: Peer Performance

by | Aug 18, 2021 | Portfolio Review, YouTube Channel

Investors should review investment performance against peer results. How do your individual investments compare to other available assets in the same asset class? And with similar characteristics.

In our last episode, we wanted to compare results versus relevant index benchmarks. An objective comparison against the standard. But some individual funds or assets are relatively better or worse than the standard index. Do you own “best in class” holdings? Or, are your investments languishing in the bottom of their asset category?

All that and more in Episode 61 on the Wilson Wealth Management YouTube channel.

“What is a ‘peer'”? 

With investment funds, mutual or exchange traded, the peers are other funds that follow the same investment style or category. As such, they should have similar risk-return profiles as your fund.

For example, US large cap equities will differ in risk and expected return from small cap Emerging Market stocks. It may not even make sense to compare two US large cap equity funds. If one follows a value strategy and the other a growth approach. And it definitely does not make sense to compare Canadian High Yield Bonds with Japanese equities.

It is all about “apples to apples” comparisons. Find funds that are a good match when assessing.

“What is is ‘true peer’?”

A true peer makes your analysis even more useful.

If you own a fund with $100 million in assets, it may not be best compare it to one with $10 billion. The smaller fund may be more nimble and be able to invest in many more companies. The larger fund may have economies of scale, resulting in lower investor costs.

Even within the proper asset category or style, you still want to find funds that are comparable in structure.

“What are the keys to comparing peer performance?”

You can assess many different fund traits and statistics. Three key review points are performance, expenses, and risk.

Performance is what it is all about. You want to grow your wealth. So you want an investment that does well. Compared to simple benchmarks, such as inflation or risk-free rates of return. Versus its index benchmark. And to its peers.

Fund expenses are reflected in net performance. But you should also consider them separately. Fund costs are a strong predictor of future success. So you want to compare them with peers to ensure you own a low-cost product.

Risk is also important to assess separately. Even with similar funds, there may be differences in risk levels. You should look at ratios, such as Sharpe and Sortino, to assess how efficient your fund is in using risk to generate relative return. Then compare that with peers.

“Can individual stocks and bonds have peers?”

Yes. And some of the same review principles for funds apply to non-diversified investments.

For example, you want to find true peers to compare results. Toyota versus Ford. Not Google versus Nippon Steel. Or a value stock, such as Banco Santander, versus a growth stock, like Roku.

But there are many additional variables that may require assessing between peers.

There are other return statistics. Return on Equity, Return on Assets, Return on Investment. You may want to compare Price/Book, Price/Earnings, and Earnings per Share. And even more nuanced, such as Debt/Equity, Receivables Days Outstanding, and Quick ratios.

“What about asset specific risks?”

Non-diversified assets, such as individual stocks and bonds, have nonsystematic risks (stock specific) to assess.

Did the company just hire the next Ken Lay to run its operations? Or is Warren Buffett at the helm? What are the legal risks that could derail the company’s progress? Are there patents expiring that will impact future revenues? And so on.

When comparing individual companies, as opposed to a fund with many holdings, you must perform deeper dives when comparing the future fortunes of your investment and peers.

Whereas, with well-diversified investment funds, your analysis is more on systematic risk factors.

To read a little more on this topic, please refer to “Review Peer Performance”.

 

Episode 60: Index Benchmarks

by | Aug 11, 2021 | Portfolio Review, YouTube Channel

When evaluating investment portfolio performance, it is useful to compare actual results to relevant benchmarks. In this episode, we consider index benchmarks and how they can be used in portfolio reviews. Especially for passive investors.

All that and more in Episode 60 on the Wilson Wealth Management YouTube channel.

“What is an index benchmark?”

It is simply using an index as a benchmark to assess your portfolio’s performance.

Using an index to compare actual performance may provide better information than using one of the common benchmarks discussed in Episode 59. Zero return, real return, risk-free rate of return, and arbitrary returns.

All may be useful. But it is more apples and oranges than apples to apples.

Does it make sense to compare your Swiss equity fund to the inflation rate in Canada? Yes, you want to return more than the inflation rate. So it gives some feedback there. But is there not a better comparable for your investment? Possibly the Swiss Market Index (SMI) or the SMI Expanded.

Apples to apples. That is always a key to successful portfolio reviews.

“Is it easy to find an index to use as a benchmark?”

If you passively invest, you likely own an index fund. Finding a benchmark then, is relatively easy.

The appropriate index may be in the name of the fund itself.

For example, iShares Canadian Select Dividend Index ETF (XDV). Its fact sheet says the ETF “seeks to provide long-term capital growth by replicating the performance of the Dow Jones Canada Select Dividend Index, net of expenses.”

If not, the fund fact sheet will disclose the index the fund seeks to replicate.

Vanguard Small-Cap Value Index (VBR) “seeks to track the performance of the CRSP US Small Cap Value Index.”

Whether it is stated in the name or fact sheet, it is usually easy to determine the optimal index for comparison.

But even if you have to seek out a benchmark, there are over 3 million available. Covering every asset class and subclass one can think of. Whether you are investing in mega cap US companies (S&P 500) or US high-yield bonds (Markit iBoxx USD Liquid High Yield Total Return Index), there will be an index to use.

“Will one index cover my entire portfolio?”

Not usually. Typically, investors will choose indices for each asset class or subclass. Then weight individual indices based on the initial portfolio target asset allocation.

You want to select the benchmarks and weightings in advance. Part of the review process is how the overall asset allocation has deviated over time from the target. And its impact on overall risk and return.

“Why does my index fund always underperform versus the actual index, as a benchmark?”

There are a few reasons why an index fund will not exactly match the index return.

Tracking Error

How the fund is replicated will play a part. Full versus partial versus synthetic. Without an exact match, there may be minor return variations.

Timing of trades can also cause actual returns to deviate and impact tracking error. A full replication should minimize tracking error. However, the more holdings in an index, the more trading needs to be done to ensure all holdings are in the fund. Small timing errors can create price fluctuations and impact returns.

Fund Costs 

Indices are cost free. No trading fees. No shareholder communications to issue. No financial statements to prepare. No marketing of the fund. And so on.

The higher a fund’s costs, the greater the deviation from the index return.

For a little more information on index benchmarks, please read “Relevant Index Benchmarks”.

       

Episode 59: Common Benchmarks

by | Aug 4, 2021 | Portfolio Review, YouTube Channel

You created an investment portfolio. Next, you want to review actual performance against predetermined benchmarks. What is a portfolio benchmark? What common benchmarks are used by investors to assess portfolio results?

All that and more in Episode 59 on the Wilson Wealth Management YouTube channel.

“What is a portfolio benchmark?”

Pretty much anything can be a benchmark.

A benchmark is simply something than can be used to compare actual performance. Of an investment. Or the portfolio as a whole.

The more relevant to your investments, the better the comparability. To the extent possible, you should look for “apples to apples” comparisons that reflect your holdings.

“What are some common benchmarks?”

There are a few very simple benchmarks that many investors use.

Zero Return

Any return above 0% is a positive against this benchmark. Useful, in that investors tend to not want to lose money on their portfolios. Regardless of the type of assets or level of risk.

Real Return

If your portfolio earns 2%, that is good versus a zero return benchmark. But what if inflation was 3%? In purchasing power, your 2% actually lost money. Many investors factor in inflation and assess results against the real return.

Given economic forecasts for 2022 and the near future, real return benchmarks may become popular.

Risk-Free Return

Most investment portfolios assume some level of risk. Many investors like to compare their portfolio against a riskless investment. The view being that a (even low-risk) risky portfolio should outperform a no-risk one.

Currently, short-term US or Canadian Treasury bills best reflect a risk-free rate of return.

Arbitrary Return

This return can be plucked out of the air. It can be nominal or real.

For example, your current capital and funding plans for the next 20 years require a nominal annual return of 6% to amass $2 million at retirement. Perhaps you wish to annually earn at least the inflation rate plus 3%. Or just beat your brother.

There could be a logical reason for the desired return objective. Or not.

“Are these ‘apples to apples’ benchmarks?”

If you are invested in nothing but Guaranteed Investment Certificates or other extremely low-risk investments, possibly.

But more likely, these are used as a ‘sanity check’. Simple, intuitive, easy to find. Then they are combined with other benchmarks that are more specific to your actual target asset allocation and investments.

We will look at more relevant portfolio specific benchmarks in the next episode.

For a little more on this topic, please refer to “Portfolio Reviews: Benchmarks” and “Common Portfolio Benchmarks”.

   

When to Review Your Portfolio

by | Oct 16, 2019 | Portfolio Review

Investors should periodically review their investment portfolios. Based on the review, rebalancing may be necessary.

Factors that may dictate rebalancing include: individual holding performance causing misalignment with target asset allocation; material events causing a revised target asset allocation and need to rebalance to new mix; underperformance of individual holdings against peers or designated benchmarks.

How to review and when to rebalance are relatively straightforward.

But a common question is: “When? When should I review my portfolio?”

Material Event

A good idea is to review your portfolio whenever a material event occurs in your life.

That could be a market related event. The crash post 9-11. A war breaking out. A clear trend in interest rates or inflation.

If you own individual, non-diversified investments, such as stocks, events that impact the specific companies. Perhaps Apple has come up with their next iPod or iPhone concept. A revolutionary product that will change the marketplace. Or perhaps Tesla car batteries easily catch fire, resulting in major class action lawsuits.

A material event may also be personal. Marriage. A new baby. An inheritance. Job loss. These events may affect your investor profile, necessitating a change in your target asset allocation and investments.

In any of the above examples, probably not prudent to wait 8 months for your normal, annual review before assessing their potential impact on your portfolio and investment strategy.

Portfolio Risk

Not quite a “when”, but more of a “how often” issue. Though the two are definitely linked.

Many experts recommend annual reviews. In general, they are probably correct. But that is too simple a statement.

It may be wise to review a portfolio annually. But the periodicity should reflect the portfolio’s risk not the calendar.

If you invest in a basket of well-diversified, low-cost, index funds, an annual review should be sufficient. Subject to changes in material events as discussed above.

If you invest solely in small to mid-cap companies, you may want to keep a closer eye on holdings. Maybe quarterly or semi-annually. If your portfolio is made up entirely of stock options, you will want to monitor on a daily or weekly basis.

The higher the volatility (i.e., risk) of a portfolio, the shorter the time periods to review.

Investor Risk Tolerance

Similar with investors and their peace of mind.

A very risk averse investor probably cannot sit back and review on an annual basis. Regardless of what is in the portfolio. And it will likely be a relatively low risk portfolio, given the investor’s risk tolerance. This investor may want to check the portfolio weekly or monthly, even if annual may be reasonable.

Okay, the “When?”

We will assume an annual review. Semi-annual, quarterly, or even monthly are simply pieces of that pie.

Year End Review

The obvious date to review a portfolio is as of December 31. You get your year end data and review in January.

Very common. The date is intuitive. You can access lots of information, such as year end financial statements, tax information, fund data at year end, etc.

However, there are a few downsides to using December 31.

December 31 data may be a bit skewed. Stock prices may reflect tax based selling more than actual performance. Companies with December 31 year ends may speed up revenue recognition (or even increase losses) to make their annual results look strong (or clear the decks for the next fiscal year). Funds may engage in a little “window dressing” to adjust for style drift or underperforming assets they owned during the year.

What you see in December 31 data, may not always be the best measure of an investment.

Year End Costs

Another negative aspect of December 31 reviews is that most investors do them.

If you rely on a financial advisor to assist in the review, January and February will be an advisor’s busiest time of year. That may mean increased fees as demand will be high. It may also mean less attention to you.

Non-December 31 Review Date

Why not choose a non-December 31 review date?

I might choose June 30 or September 30 instead. You can also consider March 31. However, for many advisors, April is extremely busy with tax season. And then many advisors want to vacation in May, post tax. But if you are willing to wait until mid-May for a March 31 effective date, that would also work.

For most public companies or funds, these are normally quarter-end periods. There may be better or more information available at a quarter end versus a regular month end.

There may be less distortion in companies and fund results than at year end.

Your advisor may have excess available time in non-peak months. This may mean lower fees and greater attention. And, I can assure you, a grateful advisor for shifting the work load from peak demand into a traditionally light period.

Another useful feature of reviewing in July or October, is that it helps set up planning for the coming year end. Hard to discuss prudent pre-year end moves in January of the next year. But if you are considering tax planning or how portfolio changes may impact your end positions, better to consider them before year end. When there is still time to act.

 

 

 

Portfolio Review Keys

by | Sep 18, 2019 | Portfolio Review

What are the keys to a successful investment portfolio review?

Depending on your investment skills and experience, you can assess portfolios via a multitude of factors. But for most investors, there are some basics that should always be reviewed.

We have covered them in previous posts, but I shall provide a quick summary here.

Pre-Determined Benchmarks

You should always create benchmarks against which you will compare your portfolio composition and results.

Determine relevant benchmarks, using multiple benchmarks whenever possible, prior to actually building your portfolio. At the same time you determine your target asset allocation and investments. This will keep you honest when conducting your portfolio analysis on the actual allocations and performance over time.

As such, benchmarks should be based on your unique Investor Profile and the resulting target asset allocation.

Benchmarks can relate to many different areas. These include: common data or arbitrary numbers; relevant publicly available indices; actual peer and style category performance; planned target asset allocation. For better analysis, use combinations of these benchmarks that best fit your analytical needs.

Performance

Net performance drives wealth accumulation. So you want to make sure your portfolio does well relative to its benchmarks. But performance comes in many different forms.

Performance may be annualized or cover the holding period. A 100% return may sound great. But if it takes place over a 20 year holding period, the annual return may not be as nice as it appears.

Conversely, a 5% annual return may be nice if your peer group average was -10%.

Not all investment returns are the same. Understand the difference between: gross and net returns; realized and unrealized gains; base and local currency performance. Costs, fees, taxes, foreign exchange, and paper versus actual profits, will all greatly impact your analysis.

Always factor in inflation rates. A 100% return may seem wonderful, but not so much if you are living in a period of hyper-inflation. See 2019 in Venezuela as a sad example of this.

And always know what return data is being presented. Massaged financial information can lead you to incorrect decisions. For example, there may be a difference between mean and median returns. There may be further variances when factoring in time weighted versus dollar weighted returns.

Portfolio Composition

A key to any analysis is an apples to apples comparison. Especially relating to portfolio risk.

And equally applicable when investing in asset subclasses as risk can vary from the overall asset class risk-return profile.

You want your benchmark to reflect the composition of your portfolio, where the benchmark is an index, peer group member or average, or target allocation.

Reflect, not necessarily exactly mirror. Unless you are investing in the index itself.

You want your portfolio to reflect the benchmark in respect of expected return and risk.

If you use a risk-free rate (i.e., Treasury bills) as a benchmark for a portfolio made up of shares in unlisted small companies, the comparison becomes irrelevant. You are trying to compare a risk-less benchmark against a high risk portfolio. Any comparative data will make no sense, other than simply knowing your performance relative to a completely safe asset.

The same holds true comparing the Dow Jones 30 to the unlisted small cap stocks. Or to Argentinian or German companies. There are different return expectations and volatility between the groups. That makes comparisons difficult.

Asset Allocation

You want your portfolio’s asset allocation to reflect your target asset allocation.

And your chosen benchmarks should also reflect your target asset allocation.

If you have a simple target asset allocation of 70% U.S. equities and 30% U.S. bonds, both your benchmark and actual portfolio should reflect this. Perhaps your selected benchmarks should be the Standard & Poor’s 500 for equities and the Barclays Capital Aggregate Bond Index for the bonds. Weighted 70% and 30% respectively.

Material Variance

A material event is one that triggers action on your part.

For example, perhaps you are considering buying a car. Color, interior design, stereo system, horse power, etc., may all play a part in your decision making. They will have a cumulative effect on your choice. But individually, the car’s color or its stereo system probably will not be a deal breaker.

Instead, a sale price, low interest financing, warranty, consumer satisfaction surveys, etc., may play more important roles in your decision. If your potential vehicle is considered a lemon, you may decide to choose a different make. Or if you can get excellent financing terms, you may be swayed in your decision. Any one factor can make or break the purchase decision.

These latter factors are material events. The key points that affect decision making.

You need to identify the make or break points in your portfolio analysis. And these points are largely driven by who you are as an investor. Your risk tolerance, investment objectives, constraints, etc. Your investor profile.

These will obviously differ from individual to individual.

For example, some risk averse investors may not be comfortable with any negative portfolio returns. Others may accept short-term or minor losses, say no more than 10% of invested capital. And others may accept losses of 25%, 50%, or more before taking remedial measures.

While you want to ensure that your portfolio does not underperform, it can be a tricky process. It is a fine line between fine tuning a portfolio and in either waiting too long to make changes or adjusting too often.

A common material review point for investments in funds is peer review. If your fund is ranked in the bottom half of its peer group over (say) 3 years, it may be worth considering a change. Either it is selecting poor investments relative to other fund companies in the same asset category. Or it is extremely costly in fees and that is dragging down results. Either way, other investment options may be preferable.

We will consider when and how to rebalance a portfolio next week.