There are lots of reasons why people entrust their wealth to money managers, with saving time, hassle and worry being right up there. Yet it goes without saying that most are motivated by the hope they will achieve better returns via a professional than they could on their own.
It stands to reason that institutional-grade research and whole teams of specialists beavering away on investment strategy should deliver better results than even the most diligent DIY-er. However, that does not mean that all investment managers are created equal, or deliver the same returns.
As we always emphasise, investors need to be looking beyond headline figures to get at returns net of fees. It may be worth paying a small premium for a manager that really does deliver superior results. But you have to be sure that is the case. It is all too easy to be bamboozled by performance benchmarks.
I am not suggesting for a second that this is deliberate obfuscation; no reputable firm would dream of such a thing. Rather, it is that the selection (and composition) of benchmarks can be a subtle affair. So, let’s dig into the key considerations that will allow you to spot a true winner.
It bears repeating that what you are looking for is outperformance - meaning the degree to which your manager achieves gains in excess of general market rises. Otherwise, you may as well have bought a simple tracker or Exchange-Traded Fund, which are generally very low cost (for more on the merits of active versus passive investing, see here).
Best fit, rather than best known
Of course, if your portfolio is diversified properly, it should not represent equities from just one index, nor indeed be populated just with stocks. The equities element invariably needs to be stabilised with a significant (perhaps 40%) allocation to bonds, and both allocations diversified within themselves. We’ll leave the potential to allocate to alternative asset classes too for another day.
As you will now be appreciating, it may not be particularly meaningful then to gauge your portfolio’s performance against, say, the FTSE 100. This is often what people do have in mind because it’s easy to track, publicly available and is taken as a proxy for how the UK economy is going. But to measure the performance of a globally diversified bundle of assets that also includes bonds at least? Questionable.
What investors really need to have in mind is a benchmark representative of the actual structure of their portfolio - best fit, rather than best known. And this is where things get tricky.
When you first start to work with an investment manager, agreeing a benchmark is one of the most important tasks in setting your mandate. A sophisticated firm might suggest a multi-asset “composite” benchmark which blends several to reflect the mixture of assets (and markets) you will actually own.
Others, meanwhile, may be more target-driven, aiming to deliver returns a certain percentage above inflation, as measured by the Consumer Price Index. This can be particularly helpful if you are running a portfolio (or sub-portfolio) to meet a specific life goal with a firm time-horizon.
These two approaches have (respectively) accuracy and a recognition of progress towards goals to recommend them. However, investors are likely to appreciate a more comparative approach alongside – namely, one which measures how well your money could be doing elsewhere.
Like for like
Firms now commonly take part in industry-wide benchmarking efforts, where they submit figures for “cautious”, “balanced” or “growth” to be ranked against their peers. The best performers will likely shout their lead ranking from the rooftops. It may take some digging to discover the laggards though.
Looking back over various time periods is also of vital importance. You need to know if your provider is performing consistently over time, particularly if track record is being used to justify slightly higher fees. A few quarters of under-performance needn’t signal a poor manager necessarily, as long as these can be well explained and are later compensated for.
Really, context is all, and this is where things get trickier still. During the pre-2020 bull run everything really went up, making it hard to distinguish skill from luck. If the vast majority of gains are driven by markets marching forward, then you have to ask how much you should really be paying for that.
In short, if you are paying for something special, then you must ensure you are really getting it - in net performance terms and relative to other providers. It hasn’t historically been made very easy, but comparing performance like for like and over various time periods can reveal an awful lot.
We designed ARQ because we know that ensuring real value for your money can feel like a bit of a battle. In that context, having a holistic overview of all your investments, fees and performance is the most powerful weapon a wise investor can have.