Few advisors would argue that performance reporting can be a distraction. Who among us hasn’t endured that uncomfortable client meeting where the conversation focused on the one manager that underperformed? Fortunately enough, the sophistication of performance reporting software today allows an advisor to at least drill down to an explanation. But from a practice management standpoint, we suggest far more beneficial conversations can be driven by a performance report tailored to help the client focus on the bigger picture. Granularity is fairly easy; the trick is to broaden the discussion.
Let’s Talk About the Sum of the Parts
In the past, performance reports were configured to focus on the pieces of a portfolio. Indeed, for years the industry focused mostly on the security level as the source of added value. Today, it’s generally accepted that the main sources of alpha are asset allocation and portfolio construction decisions. The art and science of portfolio management, meanwhile, has evolved from one-size-fits-all investment products to constructing dedicated portfolio solutions designed to reach the return objectives defined by the investor.
Against this new backdrop, more thoughtful firms are focusing their performance reports on the sum of a portfolio’s parts: the total portfolio, in other words. Some are even aggregating accounts at the household level. The overhanging question in this model, of course, is how do you meaningfully benchmark a total portfolio?
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Let’s Talk About What Money Will Buy
We know that measuring total portfolio performance against a general market index like the S&P 500 is not the answer. This kind of basic benchmarking does little, if anything, to indicate how well an individual investor’s total portfolio is performing versus expectations. Only slightly better is a “custom policy benchmark,” which is created by blending the benchmarks of the underlying positions and assigning the same weight as in the portfolio. This approach offers a more relevant comparison for the total portfolio, but in highlighting the relative benefit of manager selection, it opens the door for the client to focus on any one of the portfolio’s underlying parts.
The best way we know to place emphasis on the overall portfolio and shift an investor’s view toward a long-term goal is employing a real return target for comparison. Real return is defined as the performance above inflation, its object being to ensure that a portfolio does not diminish in value over time. Pension funds take this approach by using actuarial rates.