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”.
