Benchmarking your portfolio performance is crucial for a couple of reasons. First, it provides a starting point for your financial advisor/portfolio manager to gage your risk-tolerance and return expectations. Second and more importantly, it gives you a basis of comparison for your portfolio performance against the rest of the investable market.
Benchmarks come in all different shapes and sizes, with some tracking certain segments of the stock market like the S&P 500 Index to others tracking entire asset classes. With so many available indexes to benchmark your portfolio against, the question then becomes which ones to use.
We believe that the best benchmarks are the most simplistic, as they provide a basis to compare every strategic investment choice you make. In addition, we think that every portfolio should hold an individual benchmark for every asset class it holds, considering it will be easier to evaluate the value added by your financial advisor/money manager in each of these investment categories. Exclusively using the S&P 500 Index, which is a good gage of the performance of theUS stock market, would not be a strong measure of how a diversified, multi-asset portfolio looks in terms of risk and return.
For stocks, we recommend that you use the MSCI ACWI All Cap Total Return Index because it covers the entire global stock market. In addition, it is the most simple, diversified equity fund one could invest in. Every deviation from this index (like investing more in US companies than foreign ones) is a conscious choice made by the manager of the portfolio and those decisions can result in differing returns. Those returns can be most accurately interpreted through a broad stock market index. The FTSE Global All Cap Total Return is another global equity index that we believe has the breadth necessary to be an accurate gage of how your stock holdings performs relative to the market.
For bonds, we suggest using the Citigroup 1-month Treasury Bill index for slightly different reasons. Since bond allocations are usually meant to lower risk in a portfolio, the safest and least volatile bond investments are what you should compare your fixed-income returns against. A 1-month Treasury Bill is considered the shortest and safest bond investment that a portfolio manager could utilize and any choice made to increase duration and risk on the bond side would show up in the returns of your portfolio compared to this benchmark. In this case, instead of benchmarking against the broadest available bond index, you should benchmark it against the intentions of entering into the asset class. This means choosing a benchmark that is aligned with safety and security.
With ETFs allowing investors to unlock previously hard-to-reach asset classes, it has become increasingly necessary to add new benchmarks to these innovative portfolios that cover more than just your typical stock and bond model. Popular new investment options in commodities, real estate, currencies, private equity and hedge funds (considered to be alternative asset classes) are frequently showing up in retail investor portfolios, yet many still use stock and bond indexes to track their entire investment performance. Allocations to these alternative asset classes should be treated just like investments in stocks and bonds and thus should be evaluated with appropriate benchmarks. In order to more accurately gage returns in these segments of multi-asset portfolios we will look at some potential indexes for these new investment options that are in line with the simplistic benchmarking approach.
Commodities: S&P GSCI Total Return Index
Real Estate: FTSE EPRA/NAREIT Global REIT Total Return Index
Currency: Barclay Currency Traders Index
Private Equity: Red Rocks Globally Listed Private Equity Total Return Index
Hedge Funds: HFRX Global Hedge Fund Index
These are not the only asset classes that ETFs have unlocked for the retail investor (such as investment opportunities in rare whiskey with the ETF (WSKY) which could be benchmarked against the broad Whisky Apex 1000 index). There are also many other alternative classes that some institutional and high-net worth investors have access to but ETFs have yet to track. These include but are not limited to collector’s items such as automobiles, stamps, and coins as well as private investment opportunities in the real estate space. Even though these investment categories do not yet have an ETF tracking them, there are broad indexes that investors should use to gage performance in these asset classes.
As the financial world continues to innovate and create new products that give retail investors more power to diversify into new asset classes, your portfolio needs innovate and adapt as well. Without the use of these all-encompassing, intention-driven benchmarks, evaluating risk and return in multi-asset portfolios becomes increasingly difficult. By assigning a simplistic and broad benchmark to each asset class, you can more accurately measure the true effect that strategic investment decisions have on your portfolio.
By: Quentin McTeer - Intern Research Analyst
Private Equity: http://www.alpsredrocks.com/glpe-index.php?section=returns
Click here to schedule a consultation with one of our financial planners.