Benchmarking – Deciding between risk and return

Our decision to invest is usually driven by one factor – to make healthy returns. And whilst any investor, seasoned or not, will appreciate that the value of investments can fall as well as rise, the opportunities that do exist to increase the value of our savings is enough to keep the financial world going round.

When we make the decision to invest, it’s important to set a reference, or starting point, from which to measure success and gauge the relative performance of our portfolios. Benchmarks are one such indicator and serve a crucial role in helping a portfolio manager to construct a portfolio and direct how that portfolio should be managed on an ongoing basis.

Benchmarks generally tend to be set against sector averages and market indexes, such as the Dow Jones or the FTSE 100. Using an index, it is possible to see how much value an active manager adds and from where, or through what investments, that value comes.

With Managed Portfolio Services, where all clients with similar risk objectives are invested into the same multi-asset portfolio, benchmarks tend to be set against composite indices, in a similar way to funds, focusing on absolute returns as the guiding performance indicator. For clients with a more bespoke portfolio, advisors need to be clearer about the risk that clients are prepared to take and insist that some measure of this is used as a benchmark.

There has been a change in mind-set over the past 5 years or so1 where advisors now see investment success as delivering expected client outcomes but at a risk level they are comfortable with. Whilst judging success on performance is important, it is not enough – it needs to be viewed in conjunction with a measure of risk that is suitable for each client. It is all very well achieving great levels of return for a client in a short space of time but, if the client is uncomfortable with the excessive risks taken to make that money, the strategy is probably not going to be sustainable over the long term.

Whether we are risk averse or risk takers, we all know that portfolio values can rise as well as fall – performance measurement therefore needs to be taken over a reasonable time period, say 3 to 5 years, where market cycles have time to play out.

If you would like to discuss the performance of your portfolio or adjust your attitude to risk, please contact your Finura Partners advisor today.

Sources:
1 http://defaqto.com/advisors/zones/dfm-zone/features/benchmarking-in-the-dfm-world/ and
https://global.pimco.com/resources/education/understanding-benchmarks