An investor can be perfectly satisfied with the performance of their portfolio. But is that enough to assume that it has optimized its performance? How do you make sure your portfolio is performing?
Through sites like Morningstar.ca, investors have access to the returns history of many mutual funds. For each one, we find information such as their performance, quartile rank as well as how they compare to other funds in the same category.
One thing to know: investing in a mutual fund is essentially buying into its management team and their process. It is not uncommon for a mutual fund mandate to go through a phase of underperformance, sometimes for many years. However, if the mutual fund’s management team and mandate are well chosen, it will eventually show adequate performance and good growth. It can take three, five or even ten years. Therefore, the investor should be patient with the mandate they buy. Good portfolio managers (such as Benjamin Graham, David Dodd or Warren Buffett) are never in a rush. They assess the company’s ability to generate, grow and protect its profits. It may take many years for the general market to recognize the value of such companies which requires patience from the investor’s standpoint.
As previously mentioned, some sites allow investors to learn more about the performance of the mutual funds available to them. However, for a portfolio that is built mostly of mutual funds, looking only at their individual returns can be misleading. Take a common fund with a high return for which the investor holds only a small share. Its returns, while excellent, will have little impact on the overall performance of the portfolio. To best assess the portfolio’s performance, one must look at the full picture.
As for a portfolio of stocks or bonds held directly, it is possible to compare their performance to an appropriate index. For example, Canadian equities will be comparable to the S&P/TSX Composite Index, which is the most popular reference for Canadian equities. Of course, this would only benchmark that portion of the portfolio. As previously mentioned, it is important to favor an overall vision, which requires weighting different benchmarks according to the overall proportion of each type of investment in your portfolio.
Weighting as a comparison tool
If a portfolio consists of 30% Canadian equities, 20% U.S. equities, 30% foreign equities (and the balance in bonds), this weighting will be used to compare its performance to that of another portfolio that has the same investment profile. It can also be compared to a portfolio of stock indexes with an equivalent weighting (examples are available on Morningstar.ca). On the other hand, we must not forget to deduct from these “model” returns certain costs related to the acquisition of indexes. Reasonable fees associated to certain financial products, or fees paid to an advisor if the investor has used his services to build his portfolio, are to be expected.
A return that takes risk into account
The main objective of a portfolio is a good return, but not at any price. In other words, the investor should aim for a near-perfect balance between returns and risks. There are several types of risk that could be summarized as follows: risks that generate recoverable losses (market volatility, or fluctuation) and risks whose potential losses are permanent (a bankruptcy). Returns can sometimes be “inflated” if higher risks are accepted. Inevitably, such a strategy comes with a probability of losses that will be just as high, bringing to light the importance of assessing risk-adjusted returns.
An in-depth discussion with a manager or professional advisor is strongly recommended. Our team can help you make sense of the performance and risk of your portfolio. Feel free to reach out and we will be happy to share our expertise.