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| Investment performance | |
| There are a number of ways of measuring and analysing investment performance. The most obvious method is to compare performance against a benchmark. A benchmark helps to identify expectations, set targets for investment managers and monitor whether those objectives and expectations are being met on an ongoing basis. By measuring portfolio returns on a cumulative and period-to-period basis, say quarterly, you are able to ensure that the portfolio is being managed according to your requirements on a consistent basis.
One thing to be careful about is not to swap the benchmark to simply reflect changes that the manager has introduced in his portfolio. Part of the skill of the manager is to make asset allocation decisions within the terms of the mandate. If they go over-weight Japan, for example, and you then adjust the benchmark to replicate this, it will not show in the performance measurement and you will have neutralised the effect of his decision.
It may be best to use a tailored benchmark to reflect your individual risk profile and investment objectives. A tailored benchmark should reflect the mix of asset classes that you hold in your portfolio.
One approach would be to construct your own benchmark using a range of quoted indices that are available in the financial press or on specific websites. This approach, however, can be difficult as there are a multitude of different indices available and some care is required to match the appropriate index to your assets. Perhaps the simplest example is that of benchmarking your UK equity exposure, depending on the composition of your UK equities. Either the broader based FTSE-All Share index may be appropriate or you may prefer to use the more concentrated Blue Chip index of the FTSE-100.
Most broadly diversified portfolios will contain overseas equities, fixed interest (bonds), cash and, increasingly, alternative investments such as hedge funds, commercial property and commodities. Selecting an appropriate index for each asset class and calculating performance for a portfolio in composite can therefore be both time-consuming and requires some experience.
Even using cash as an absolute “risk-free” benchmark is subjective as arguably you should also factor in the incremental rise in inflation on a cumulative basis to match your investment timeframe as inflation erodes the purchasing power of cash on deposit.
It can be argued, therefore, that the simplest way for you to measure your portfolio performance in composite is to choose one of the ready made private investors indices. There are three main organisations that provide this data and broadly the principles are the same in that each offers three-model portfolios dependant on your investment objectives. The portfolios are either income generating (mainly UK equities and bonds), balanced (some bond exposure but more emphasis on equities including overseas equities) or growth orientated portfolios (a predominantly equity bias with limited cash and bonds exposure).
The Financial Times publishes private investor indices in its weekend edition while WM Company offers a fee-based subscription service widely used by professional investors. Trustnet provides daily data on Adviser Fund Indices through its website.
Investment managers choose benchmarks against which they will compare their own performance. But you should not automatically use their chosen benchmark. You should evaluate how relevant a benchmark is to the manager’s investment approach and risk profile. If necessary, get independent advice on this. There are many professional analysts who can assist you.
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