A few weeks ago, I highlighted the importance of putting the returns reported by those around us into perspective in a column which prompted this very interesting question from a reader, Josianne, who wrote to me this: “I really appreciate my financial planner : I feel confident, respected in my choices and well supported. Everything would be perfect if… I didn’t have any questions about the performance of my portfolio. I realize that in four years, the balance of my investments is less than the amount of my investments. It’s really discouraging to think that if I had put that money into a 0% interest account, I would still have a few thousand dollars more left today than I have right now. How do I evaluate the performance of my portfolio and compare it? How do I know if the poor performance of my portfolio is linked to the markets or, on the contrary, if there is truly underperformance? »
Distinguishing personal return and fund performance
I was able to analyze his detailed investment statements. The first point to make is that these present the cash flow weighted return. This calculation method is very personalized, but it does not allow you to learn much about the historical performance of the funds making up your portfolio. Since her investment account was opened at the end of 2019, the internal rate of return displayed is strongly influenced by the changes made to the composition of her portfolio (Josianne added a third fund specializing in “green” stocks to allocate 50% of her portfolio in 2021) and withdrawals made from the funds to pay the fees.
In order to know if the underperformance of her portfolio is more worrying “than the average”, our reader would benefit from doing research on the funds making up the latter. The good news is that she only has three, so the work won’t be too tedious! Different paid tools allow you to compare funds in the same category (e.g.: global stocks, balanced funds, Canadian bonds) of assets.
All funds are ranked according to their quartile rank within their category. Past performance compared to peers is no guarantee of the future, but there is reason to question the use of a fund still relegated to the 3e or 4e quartiles of its category… The supply of mutual funds and ETFs being abundant, a portfolio can easily be made up of more efficient funds. Good to know, the quartile rank over a period of more than three years is more significant than that over the short term.
Investment beliefs
The year 2022, historically unfavorable for the markets, both bond and equity, strongly colors the performance of its portfolio. Josianne questions her choice to have allocated 50% of her portfolio to a responsible investment fund. By analyzing her documents, I observe that she invested in it at the time when it had reached a peak in 2021. The analysis shows that it is this same fund which canceled the returns of the other two, more diversified in terms of sectors of activity.
Does this mean that she must reconsider this investment choice? Not necessarily ! Selling now would magnify your loss (buying high and selling low is the opposite of the basic principle of a rational investor). This is perhaps the fund that will bring significant added value to its portfolio in the coming years. For its next investments, it could restore the diversification of its portfolio.
However, with markets being very volatile, Josianne could question her risk tolerance. His portfolio is currently 95% equities. If she is uncomfortable with the fluctuations she observes, the question arises. His case also illustrates the importance of the entry point on short-term performance, which is unfortunately impossible to predict. For future investments, I advise him to use periodic purchases in order to better manage the psychological impact of the marked drop in a security following its purchase.
Finally, to analyze the performance of a portfolio in relation to the markets, it can be tempting to compare it to benchmark indices. However, we must be careful to choose a representative performance (there are many indices) and make the comparison over a long period. The much more enlightening alpha ratio will allow Josianne to validate the performance of the funds in her portfolio compared to their benchmark index. We must then look for a positive alpha (greater than 0).
However, since everything must be put into perspective in portfolio management, it is also necessary to take into account the risk associated with this return, using the beta and Sharpe ratios (risk-return profitability).
A few tips
Be sure to compare equivalent time periods. To know if the performance of a fund or portfolio is faithful to market results, look at the alpha ratio compared to the benchmark index. To evaluate the performance of the funds used in your portfolio, compare them to other funds in the same category.
Keep in mind that some stocks may disappoint in the short term and have been selected for their long-term return potential. In this case, the fund facts are more important to analyze than the short-term performance.
The shorter the period since opening the account, the more you should be interested in points of analysis of the portfolio other than its performance: its composition, the risk-return relationship, the manager style, the objectives and mandates of the funds used, etc.
Involve your advisor in the comparison and tell him about your doubts: after all, he has access to all the tools, to the history of portfolio composition choices, and he should have your success at heart.
Financial planner, Sandy Lachapelle is president of the independent firm Lachapelle Intelligent Finances.