Share with your clients: What Are You Benchmarking in 2019? (est read time: 5 mins)
Dan Kemp, Chief Investment Officer, Europe, Middle-East & Africa
Eugene Visagie, Portfolio Specialist, South Africa
- Benchmarking your financial progress is a key tool for success, but it’s often done referencing the
wrong things and over the wrong timeframe
- Benchmarking is often done as a rear-vision exercise. Decision-making should be forward-looking
- At its extreme, incorrect benchmarking can leave investors prone to “chasing winners”, which may
hinder their ability to meet their financial goals
- Benchmarking against peers or an index is a concept used to help define whether an investment
proposition is delivering value. It is well intentioned; however, we should acknowledge the
- Investors have unique goals, so any benchmarking should ideally align with those goals.
When you invest, it’s important to remember that you’re making a short-term sacrifice for a longer-term gain. In most instances, the objective is financial prosperity, security, or the attainment of a goal, which are all typically longer-term in nature. This may sound obvious, but it highlights one of the biggest issues we find around this time of year. Primarily, investors often spend their time reviewing performance against a designated benchmark, but this can result in a biased comparison, where the wrong things are compared to each other over the
wrong timeframe. We’ll elaborate on this, but want to ask you throughout: What will you be benchmarking in 2019?
Imagine a scenario in which you achieved 5% over 2018. Was this a success? Perhaps. How about if we added that the return was 4% less than the previous year, 3% above the peer-average, 2% above inflation and 1% lower than your desired level of return. Was this now a success? Maybe…
How about now adding the knowledge that one asset was attributable for your total return. You held other assets, but these netted off and went sideways in aggregate. You also took more risk than you’d have liked, which made you anxious at certain periods of the year. What about now? Hmm…
This example hopefully helps illustrate the complexity of appropriate benchmarking. There are many moving parts, some of which you can control—risk taken, assets held, timeframe considered—and many others you can’t.
As individuals, it’s important that we can each measure our own success in a way that is appropriate to the circumstance. Ideally, this will include a robust and repeatable framework, which may or may not use benchmarking tools. The list of tools at your disposal is theoretically endless, although must be appropriate.
What Tools Are Available?
As an industry, most investments options are benchmarked against one of the following:
- Peer relative. Often done in quartiles, where portfolios are ranked against comparable managed portfolios on a scale of 1 to 4
- Index relative. Where a portfolio is measured against a passive benchmark net of fees
- Absolute return. Often seeks to return a consistent positive level over time, regardless of inflation, interest rates, and other variables
- Real return. Seeks to deliver a level of return over inflation, growing the purchasing power of the portfolio over a defined period.
Each of these methods has advantages and disadvantages, with the most applicable likely to depend on what you are trying to achieve. For example, many asset managers benchmark against relative outcomes—from index-relative (fuelling the active versus passive debate) to peer-group comparisons— all designed to sort the winners from the losers.
This relative benchmarking is well-intentioned and can be useful if considered over longer periods. However, it can sometimes misalign to the reason we invest. Perhaps most prominently, it sometimes leaves investors inclined to favour the “best” performers and yearn to be part of this echelon. Investors similarly look down on the “worst” performers and sell in frustration.
This shouldn’t be underestimated. If an investor feels that they are underperforming, they will be psychologically prone to act. At its extreme, this impulse can lead investors down a garden path where they expect to be top-quartile performers at all stages of their journey – regardless of how that links to their desired destination.
What Is the Ideal Benchmark?
The best benchmark is one that is forward-looking and aligned to your financial goals. In a perfect world, every investor deserves their own framework to benchmark success, with transparency, measurement, and perspective all to be embraced. The challenge, of course, is that a forward-looking assessment is incredibly difficult to quantify, and there is no such thing as the “one-size-fits-all” approach. Benchmarking tools—such as those listed above—are powerful, but you cannot unshackle the backward-looking nature of them. What matters to an investor is whether their investment might be expected to help them achieve longer-term gains into the future. This mismatch requires care and highlights an important point around process versus outcome.
Specifically, it’s entirely possible to have a strong process (or a good decision) with a bad outcome, just as it is possible to have a poor process with a strong outcome. However, more often than not, a strong process will prevail and result in strong outcomes and vice versa. This is a key reason why we stress that people make comparisons over a longer time horizon — it allows the strength of the process (or the
combination of many decisions) to unveil itself.
To bring this to life, we can suggest a checklist to reinforce the link between goals and your investments. We split this into two distinct categories, where the idea is to first align your framework to your ambitions and then remove emotion from your appraisal process:
Checklist 1: Aligning Your Framework to Your Ambitions
- Is there a clearly-defined financial goal your portfolio can map to?
- Are you appraising your investment results over a suitable time horizon?
- If using an benchmark, is it realistic and investible?
- Do you need to account for inflation?
- Have you accounted for risk taken?
- Does your portfolio—as a whole and each position within it—stand up strongly in a forward-looking context?
Checklist 2: Avoiding Bad Decisions
- Can you avoid the recency bias (focusing beyond the recent past)?
- Are you aware of your own loss aversion (avoiding selling in a panic)?
- Can you avoid the overconfidence bias (by thinking probabilistically)?
All things considered, appropriate benchmarking is a powerful tool—both analytically and behaviourally. Done correctly, it can help investors stay on course and focus on the right things, but done incorrectly, it can have significant consequences. With this in mind, we leave you with a quote by Robert Shiller and wish you every success in 2019 and beyond.
The ability to focus attention on important things is a defining characteristic of intelligence. – Robert Shiller
This document is issued by Morningstar Investment Management Australia Limited (ABN 54 071 808 501, AFS Licence No. 228986) (‘Morningstar’). Morningstar is the Responsible Entity and issuer of interests in the Morningstar investment funds referred to in this report. © Copyright of this document is owned by Morningstar and any related bodies corporate that are involved in the document’s creation. As such the document, or any part of it, should not be copied, reproduced, scanned or embodied in any other document or distributed to another party without the prior written consent of Morningstar. The information provided is for general use only. In compiling this document, Morningstar has relied on information and data supplied by third parties including information providers (such as Standard and Poor’s, MSCI, Barclays, FTSE). Whilst all reasonable care has been taken to ensure the accuracy of information provided, neither Morningstar nor its third parties accept responsibility for any inaccuracy or for investment decisions or any other actions taken by any person on the basis or context of the information included. Past performance is not a reliable indicator of future performance. Morningstar does not guarantee the performance of any investment or the return of capital. Morningstar warns that (a) Morningstar has not considered any individual person’s objectives, financial situation or particular needs, and (b) individuals should seek advice and consider whether the advice is appropriate in light of their goals, objectives and current situation. Refer to our Financial Services Guide (FSG) for more information at morningstarinvestments.com.au/fsg. Before making any decision about whether to invest in a financial product, individuals should obtain and consider the disclosure document. For a copy of the relevant disclosure document, please contact our Adviser Distribution Team on 02 9276 4550.
How we look after your savings
- A key focus on risk management, not just the potential for returns
- Increasing your buying power
- Today’s best investment opportunities