Monitoring the performance of your investments is anintegral part of sound financial planning
The challenge is that most investors don’t have 100% of their portfolio in GICs, nor do they have 100% of their portfolio in stocks. Most have a combination of investments that include cash, fixed income, and equities.
If we accept the position that most investors have a diversified portfolio, then we have to also accept that a percentage return tells us nothing about value. Only by comparing a diversified portfolio against a passive portfolio benchmark, can you make an informed judgment about how well your portfolio did. If your passive benchmark returned 11%, and your portfolio returned 12%, then your portfolio did very well indeed.
A benchmark is simply an independent standard against which performance can be evaluated.
Benchmark performance
A good benchmark has five essential characteristics:
1. Unambiguous
The components are clearly specified
2. Appropriate
It is consistent with your objectives
3. Measurable
Performance can be established frequently
4. Current
It is based on marketable securities
5. Investable
It can be replicated and the components can be purchased separately
Benchmark Performance
UNDERSTANDING INDEXES
The Financial Post Index
In 1997 the National Post decided that all Canadian Investors needed a benchmark based on a typical Canadian investor holding a properly diversified portfolio and sensitized to the investor’s risk tolerance.
Richard Croft co-developed a set of three risk-adjusted indexes – one each for Income (Conservative), Balanced, and Growth investors. These three indexes are reported daily in the “FP Investing” section of the National Post and have become accepted as standards in the industry.
The benchmarks are investable, which means that any investor can buy the investments that make up the index. And it also means that investors should expect performance which is at least as good as the index. Established with an April 1, 1996 start date, the indexes have produced first, second and third quartile results in each three-year period compared with all global balanced funds available in Canada. That is, they have finished ahead of at least half, and often three-quarters, of comparable mutual funds.
We believe a benchmark should be challenging. The FPX Indexes are, which is why we use them as benchmarks for our portfolios.
The Real World Index
Monitoring the performance of your investments is an integral part of sound financial planning.
Suppose that last year, your portfolio generated a 12% return. Was that good or bad? Well, if you are comparing the performance of your portfolio to GICs, then the return was pretty good. If you are comparing your return to an equity index that returned, say, 20%, then the numbers don’t look so good.
The problem of course, is that most investors don’t have 100% of their portfolio in GICs, nor do they have 100% of their portfolio in stocks. Most have a combination of investments that include cash (Treasury bills, bank accounts), fixed income (bonds), and equities (stocks).
If we accept the position that most investors have a diversified portfolio, then we have to also accept that a 12% return tells us nothing about value. It’s like having a son who is seven feet tall. Is that good or bad? It’s good if he wants to play professional basketball. Not so good if he wants ready to wear clothes.
Knowing a quantity such as how tall, how much, percent return, and so on tells us nothing about value. Only by comparing a diversified portfolio against a passive portfolio benchmark, can you make an informed judgment about how well your portfolio did. If your passive benchmark returned 11%, and your portfolio returned 12%, then your portfolio did very well indeed.
A benchmark is simply an independent standard against which performance can be evaluated. A good benchmark has five essential characteristics:
- Unambiguous → The components are clearly specified
- Appropriate → It is consistent with your objectives
- Measurable → Performance can be established frequently
- Current → It is based on marketable securities
- Investable → It can be replicated and the components can be purchased separately
At Croft Financial Group we use what we call the “Croft Real World Indexes” as our passive benchmarks. These are three globally diversified index-based portfolios based on the FPX Indexes originally co-developed by Richard Croft. These indexes are diversified by asset mix and geographic region, and are re balanced annually. What makes these benchmarks different is that they are investable, and they include a basket of index-based exchange traded funds. The Croft Real World Indexes take the process a step further and adjust the FPX Indexes for a 1% management fee, about the average fee paid by Canadian investors for portfolio management.
When we talk about asset mix, we are really talking about the percentage of the portfolio that should be allocated to cash, to fixed income, and to stocks. The asset mix is critical, because it determines 85% to 90% of the total return of your portfolio.
Unfortunately, most investors spend too little time understanding asset mix. They buy a specific fund or a certain stock based on its past performance or its potential return. The asset mix is determined by default.
Typically, investors fall into one of three basic categories: conservative; balanced; or growth. You can argue, as some financial institutions do, that three categories are too generic. However, we believe that each client deserves a personalized asset mix that can be accommodated by fine tuning the weightings within our three categories. Bottom line, asset mix is the priority, and for every client there is an appropriate personalized asset mix.
Cboe S&P Buy Write Index
The CBOE S&P 500 BuyWrite Index (ticker symbol BXM) is a benchmark index designed to show the hypothetical performance of a portfolio that engages in a buy-write strategy using S&P 500 index call options.
The term buy-write is used because the investor buys stocks and writes call options against the stock position. The writing of the call option provides extra income for an investor who is willing to forego some upside potential.