Let’s start with an example. Say you hire a money manager on January 1 of a New Year, and your objective is to give that manager one-year to prove his or her worth. After one year, the manager produces a +20% return for your investment portfolio. That’s fantastic, right?
Not necessarily! What if that manager’s focus/approach was to manage a portfolio of global stocks, but the MSCI World (an index that tracks global stocks) was up +40% that year? In that case, his or her performance was not so great comparatively.
That’s an example of how you can use ‘benchmarking’ as an investment tool—it gives you a metric to measure a manager’s performance on the basis for which you hired them. Looking at the performance of different asset classes can help make the point clearer.
For 2015, if you hired a small cap manager that was down 15% for the year, you should probably question the manager as to what went wrong—and find out what’s being done to correct it. Small cap as a category was only down -6.4%. Losing 15% is too much. In the same vein, if your small cap manager was only down 3% for the year, you probably should refrain from getting too upset or disappointed by the negative performance. The manager actually outperformed the category he or she was investing within, which is a positive outcome for the investor.
4 Things to Know about Money Manager Benchmarking
1) It’s an Effective Tool for Investors – benchmarking is one of the more useful tools investors have to measure performance and aptitude. As part of a diversified portfolio, you may have different managers you hire to perform different functions—an international equity manager, a small cap growth manager, Emerging Markets, large cap value, and so on. If the hired manager uses a benchmark—like the MSCI World, for instance, you should expect them to consistently have performance comparable to, or better than, the benchmark.
2) Don’t Focus on One Year – any manager can have a stellar or disappointing year, so it may not make sense to flock to a manager that has a great year (chasing performance) or fire a manager after a disappointing one. What matters is whether that manager can outperform the benchmark over time.
3) Look for Rolling Returns – there’s a catch to ‘outperforming a benchmark over time’ that investors should keep in mind. A manager can create long-term outperformance just by having a strong positive year in a negative year for the benchmark. For example, in a 10-year period, let’s say there was one big down year where the manager was positive. The manager could probably underperform in all other 9 years and still have long-term outperformance. That’s where looking at ‘rolling returns’ comes in. Rolling returns will eventually weed out the one ‘lucky’ year and expose whether or not a manager is consistent. Outperforming the benchmark over time is great, but investors should look for a manager that consistently does it. Rolling returns will give you that insight.
4) Beyond Benchmarking – using a benchmark to measure performance is critical, but it’s also important to remember the other reasons you hire a money manager—excellent service, long-term consistency, deep experience, continuity. Past performance is not indicative of future returns, so it’s important to evaluate the manager strategy to see if you feel they are equipped and prepared to keep delivering consistent performance.
Check Your Money Managers Relative Performance
If you have a money manager you’re not sure uses a benchmark, or if you want us to evaluate how your portfolio stacks up against its benchmark, give one of our Wealth Managers a call. We can help you track performance and show you whether your various money managers are up to snuff. You can give us a call at 1-800-541-7774 or start a conversation here.
