Friday, May 20, 2011

How is My Portfolio Doing?

Still feeling confused and unsettled by one helluva wringer of a meeting with my financial advisor on Wednesday.

Every now and then, I try to tackle the question of "Is my financial advisor handling my mutual fund portfolio well?" or, more basically, "How is my portfolio doing?"

I have never really gotten a useful answer to this, and it's largely futile to ask another financial advisor to analyze your portfolio because they will generally angle to get you to switch advisors.
(That said, ScotiaBank will dissect your portfolio through an analysis tool that dissects it with MorningStar mutual fund reports, that show what you're invested in and how each fund performed over the last few years. You can at least take that with you for what it's worth.)

Mutual fund portfolio critiques have taken various forms, including simple "did it outperform index such-and-such", to "what is the quartile ranking of the underlying funds?"

Complicating my quest to find an answer to this is that speaking to my financial advisor about this often provokes more of an emotional response than anything. All too quickly it becomes a question of trust -- "It sounds like you don't trust me anymore!"
To be fair, though, I was grappling with what to ask and what would qualify as an objective measuring tool, and that caused the whole meeting to meander and stretch out far longer than it should have gone. We digressed into talking about risk and where else the portfolio could go, and that sidetrip cost a lot in terms of time and focus.

I was honestly baffled that there was no objective benchmark. I couldn't shake the sense that the portfolio should have done better somehow, but I couldn't illustrate it and the answers I got was hard to interpret.

Answer number 1: "It made you money. ___% is a good return."

We arrived at this by (Current Portfolio Value - Net Amount Invested) = Money Made.
(Money Made / Net Amount Invested) = Return%.

Since (Net Amount Invested) wasn't an initial lump sum, Return% is actually an understated amount because we are assuming that all the money had equal time to grow. That is, Return% cannot be evaluated as the total return after whatever number of years I have been with my financial advisor.
(By the way, given a starting and ending portfolio value and date, you can calculate an annualized rate of return using this handy online calculator, "Show Me The Return!".)

So far I understood where my financial advisor was going with this. But the answer was still mostly subjective/emotional. It seemed to be trying to elicit an emotional answer to questions like "Does this return look/feel good enough to you?"
Add to that the complication that my financial advisor honestly looked offended. Which I could understand if the Return% she showed me was in fact very good.
The problem was, I had no idea if it were actually a good percentage. I had nothing to compare it to.

Somehow I groped my way to expressing that question -- against what benchmark can we evaluate the portfolio's performance. Was 12.46% in 2010 a good return? -- That is, "good" compared to what?
The pat answer was that there was no benchmark because none of the basic benchmarks people talk about are relevant to my risk profile or portfolio composition. For example, if you pulled out, say, the S&P/TSX Composite which returned 17.6% in 2011, then it looks bad. If you took the S&P 500 which returned 9.5% in 2011, then it looks great. But since my portfolio had a chunk in Asia, the MSCI EAFE would have to be factored in, and it returned only 2.5% in 2011.

Another way to look at indexes might be to say "that's where I should have been invested". But that's hindsight thinking and it doesn't take into account either portfolio risk management or positioning the portfolio to buy low now and sell high later.
And it would also mean that from 2001 and 2002, you would have to accept that (for example) a -12% return was average because that's how the S&P/TSX Composite did. Using an index doesn't evaluate whether your advisor adequately protected you by investing in bonds and softened the blow. It also won't tell you that because they had arranged your portfolio to protect you from that sort of thing, that it wouldn't achieve 17.6% in 2011.

So I was ready to drop the whole index thing as too simplistic and complicated. But my advisor's insistence that 12.46% was a good return still bugged me. How did they know it was a good return if they didn't have a benchmark? So what was their benchmark.

Answer number 2: "Out of my over 700 clients, you had one of the highest returns. The average was between 3% and 4%."

I was honestly stunned. We'd already gone really overtime and my head was spinning and the advisor's emotions were running quite high at the time on top of everything else, so I didn't want to call them on the obvious -- They used their own performance to gauge their performance. (And we aren't even opening the can of worms about being able to verify the statement -- which would really then be a trust issue and I didn't want to get into that).
That's like a teacher saying, "You are a good student because you scored an 'A' letter grade, while most students only got a 'C'". Nothing wrong with this per se, except the question was about whether the _teacher_ was a good one. What the statement doesn't tell us is whether I would have gotten a substantially different letter grade had I been under the tutelage of another teacher.
Would I have gotten a substantially better or worse return if I had been with another advisor?

I'm not sure I would have gotten a more useful response -- as opposed to a simply more hurt or hostile response -- if I had asked directly, "How do I know you are a good mutual fund portfolio manager?"
And maybe there isn't any useful answer to that either, since there could be various factors at play, just as there were for the use of indexes.

More poking around later on the internet turned up this article, written in January 2011: "How is My Portfolio Doing ... And What Should I do About It?"

It recommends building a benchmark of weighted indexes to try to mirror what your portfolio contains. I'm in the process of reading it now and will try it soon. I've touched on the complications of using any benchmark, but it's probably still worth the exercise to get another potentially useful metric.

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