There are over 60 providers and more than 1300 model portfolios in the MPS universe. That’s a lot of data to be crunched if you want to understand how they are performing. Simplifying that analysis can make it more digestible, but the risk is that you come to misleading conclusions. It’s vital to understand what’s behind any performance numbers you use when making investment decisions for your clients.
The start point is to ensure you are comparing apples with apples. Segmenting model portfolios correctly is crucial to making accurate performance comparisons.
Get the full picture
For example, grouping and comparing providers based on their equity weightings alone doesn’t do that because the total return is also derived from what else is in the portfolio, i.e. the manager’s asset allocation decisions. That could be bonds, cash, alternatives and so on and could represent 80% or more of the portfolio.
The variance in returns from those other assets could be significant and is likely to have a measurable impact on total returns, but these other portfolio constituents aren’t accounted for.
Style matters
In peer groups created within equity brackets, a further significant factor preventing meaningful comparisons is the different style biases employed by model portfolios.
Within a manufactured peer group of model portfolios with a 60-80% equity weighting, for example, there will be portfolios employing passive, active, blended, income, ESG and other investment styles. These biases will have a huge bearing on the construction of the portfolio and, of course, the consequent returns.
Of course, investment recommendations are not made based solely on performance. A client’s risk profile, objectives, preferences, and their price sensitivity will all be factors in determining the portfolio investment style and diversification strategy you recommend, and in demonstrating long term value.
Charges are just one factor when comparing the performance of passive and active strategies, while portfolios tailored to income or ESG requirements are obliged to focus on or avoid certain sectors to achieve their objectives.
A low-cost, global passive portfolio and a strictly managed ESG mandate are totally different products but likely to have similar equity exposure, but that is not a reason to compare them. They aim to meet very different needs and are likely to achieve very different returns. It’s not an apples with apples comparison and they are not suitable for the same client.
Of course, investment recommendations are not made based solely on performance. A client’s risk profile, objectives, preferences, and their price sensitivity will all be factors in determining the portfolio investment style and diversification strategy you recommend, and in demonstrating long term value.
Investing is a long game
As legendary Liverpool manager Bill Shankly said, “form is temporary, class is permanent”. Just like footballers, even the best investment managers can have dips in performance. In the short term, that shouldn’t necessarily a cause for concern.
When taking long-term investment decisions, there is always a risk that short-term factors will work against a manager, making asset allocation calls, sector positions or stock selections look like the wrong ones. Shifts in economic or market conditions, sector-specific developments, regulatory changes or geopolitical events are just some of the external influences that can go against a manager’s long-term position.
We always stress to investors the vital importance of taking the long-term view and that they shouldn’t worry about short-term volatility and returns. Similarly, giving equal weight or relevance to manager performance over one- and three-year periods is the wrong approach to assessing their capabilities.
When partnering with an MPS provider, you need to have belief in their ability to deliver the goods for clients over the long term. But performance is only one factor in making that decision. It’s also about the trust, flexibility, the quality of service and the ease of doing business that make it the right decision for you and your clients.
This article is for financial professionals only. Any information contained within is of a general nature and should not be construed as a form of personal recommendation or financial advice. Nor is the information to be considered an offer or solicitation to deal in any financial instrument or to engage in any investment service or activity. Parmenion accepts no duty of care or liability for loss arising from any person acting, or refraining from acting, as a result of any information contained within this article. All investment carries risk. The value of investments, and the income from them, can go down as well as up and investors may get back less than they put in. Past performance is not a reliable indicator of future returns.
