Monitoring Portfolio Performance

A document for all clients of Global Life & Finance Ltd that are investing money.

Stock markets contain far too much short term ‘noise’ making any assessment of performance over short time periods meaningless. Quarterly performance reviews are more likely to lead to poor decisions than prudent ones.

How frequently you monitor your portfolio’s performance can bias your perception of it. Suppose you were investing over a 5-year investment horizon in a high-risk equity portfolio.

Data from the US shows how you would perceive the portfolio depending on the monitoring period.

Consider the table above. Over the minimum 5-year time frame, equity performance has been positive 90% of the time, and so risky investments do not lose money more than 10% of the time. However, if you were to monitor the performance of the same portfolio on a month-by-month basis, you would observe a loss 38% of the time.

Monitoring a portfolio more frequently will cause clients to observe more periods of loss, and owing to an inherent sense of loss aversion, very likely to cause emotional stress resulting in them taking on less risk than may be appropriate for their long-term investment objectives.

Worse still is the danger that clients attempt to time markets based on emotion or sentiment. The empirical results here are simply appalling.

In short, if our clients understand the nature of compounding money, understand the dangers of a short term focus, and are presented with return scenarios for their portfolio (all clients of Global Life & Finance Ltd receive portfolio scenario returns pack), their expectations for return should be sufficiently calibrated.

Calibrating Clients’ Return Expectations

The emotional challenges that investing poses is the number one impediment to investment success.  The temptation to abandon well thought-out but disappointing strategies moments before they work, in order to chase successful strategies just as they are about to run their course, can be overwhelming.  How do we avoid this peril ourselves?

First, remember that economies grow at roughly 3% p.a. in real terms over the long term.  Expectations for double digit returns are therefore an exercise in hope over experience.  This is a seemingly obvious error, but one that is often made.

Secondly, it doesn’t really matter how well you do in good times; over the course of many years it is how you fare in the hard times that will determine success. Consider the case of two investments; the first, earning 10% a year for ten years running. The second, much more exciting fund makes 20% a year in seven years, and loses twenty percent in three years (the chronology of returns makes no difference). The mind’s eye pictures the high return fund as producing a return higher than the ‘low’ return fund. In fact, the first fund’s return is almost double that of the second one.

The second fund is much more likely to attract assets, as it has had bragging rights for 70% of the time. We all seek investment returns which are above average, but the route to good performance as Howard Marks from Oaktree puts it, “is through consistency and protection, not single year greatness”.

The obsession with short term results is a counter-productive. Global Life & Finance Ltd provides all of its clients with regular reports on portfolio performance, not with a view to promoting activity (in fact the opposite), but to keep our clients informed. We want our clients to know that we are actively monitoring their portfolios, but we do not want them to fall foul of their innate proclivity for activity. Inactivity, bordering sloth, is a more likely path to investment success than one which reacts to the markets constant gyration.

At Global Life & Finance Ltd our focus is on educating our clients about the nature of compounding money. We are seeking consistency and protection for our clients. Our investment process aims to deliver good outcomes. A good process clearly does not guarantee success, but stacks the odds in our clients’ favour. This is as much as we can hope for.