Measuring Returns
The Australian Financial Review reported that the top 25% of fund managers returned 30.5% in 2006-07. Is this a good return or an unacceptable return? The answer to this question is very revealing.
Recent discussions with many participants in the CMC seminar series highlighted this as a significant issue. Many people have a very poor idea of how to evaluate the returns from superannuation, mutual and investment funds. This same poor understanding is reflected in financial media that give us large headlines warning of poor performance from hedge funds, and outstanding performance from investment funds. A recent article in a newspaper tried to explain the difference between absolute return funds and funds which use a return benchmark. In other discussions, I have listened to people telling me that a 16% return on their superannuation fund was ‘outstanding’.
We have a different way of thinking about markets and our market returns. We have a choice with our money. We can keep it under the bed and watch it slowly diminish as inflation bites. (It’s higher than the official figure because the official figures excludes increases in rates and levies imposed by various levels of Government).
We can put our money in the bank and earn perhaps 6% interest. Or we can put it into the market and earn more than the rate of interest available in the bank. This is our preferred approach to making effective use of capital.
And with this comes a tricky bit in measuring the return on capital. Any return above the benchmark cash interest rate is a bonus. Any return that is lower than, or equal to the return from the market index is not a bonus. Our objective as shown in the newsletter, is to outperform the market by between 10% to 20% every year. The diagram shows how this works.
The return from the opening value of 5073 for the XJO S&P ASX 200 index on July 3, 2006 was 23.67%. The close value of the XJO index on June 29, 2007 was 6274. This is a 23.67 % return for 2006-2007. When we measure returns we use this as the benchmark zero line. We count only returns above this level. The 40% return shown in the first column is reduced to a real return of 16.33% once the return from the market is excluded. The 18% return from an investment or superannuation fund is reduced to a negative 5.67% return once the return from the market is excluded.
Aggressive and demanding investors will measure the market return from the low of 4899 to the high of 6409 is 30.8%. We keep this benchmark in reserve because it is only good luck and good fortune that allows traders to select both the top and bottom of the market. However, the returns available from the market fall somewhere between these two methods. The exact calculation method you choose to apply to the benchmark does not alter the assessment process.
Investors transfer capital to funds for many reasons. Compulsory superannuation is one. Convenience is another, because people believe they do not have the time to manage their investments. Others believe they do not have the skill. In all of these situations we are encouraged to believe that that the fees we pay is a recognition of the management skill of the fund manager. We believe we can reasonably expect that the skill from these professionals should be able to, at the very least, match the performance of the underlying market.
The bottom 25% of share funds in Australia returned a loss of 26.7% in the 2006-2007 year. These indicate a low valuation in terms of professional management skill, but the median return was – 0.4%. Similar results are likely to be experienced in other sectors of the fund management industry, including superannuation. It appears that the primary skill exercised by many fund managers is the ability to seriously under perform the market. The diagram shows the results.
At Guppytarders.com we use a much tougher and we believe, a more realistic measure of portfolio performance. Our benchmark is the average of the return available using the two market measurement methods. The 23.67% return 2006 open to 2007 close and the return from the 2006-07 low to the 2006-07 high. This gives a benchmark return of 23.67%. This sets the water line, the benchmark, the minimum return required from our activity in the market. Any return that is below this figure is simply under water.
How do we achieve this? We achieve this by active trading as illustrated in the case study examples in the newsletter. We achieve this by using an Exchange Traded Fund to passively track the market performance. We prefer to apply some entry and exit strategies to capture the broad trend movements and changes. In 2006-07 this was simple a buy and hold strategy.
The market is a tough place. We use it to grow our capital in the most effective way possible. When returns are above bank interest rates we are satisfied. When returns fall below the level available in market activity, we are not satisfied. We do not pay for the skill of under performing the market.
In coming weeks there will be many advertising claims about superior performance in difficult markets. It pays to really understanding bench market performance that is appropriate and then to assess these claims against the benchmark. The results will be surprising.
We started with a simple question. The Australian Financial Review reported that the top 25% of fund managers returned 30.5% in 2006-07. Is this a good return or an unacceptable return? This return is 6.83% better than the market. The result is a low return for management expertise. It is even lowered when management fees are taken into account.
Read more articles by Daryl Guppy.
Read more articles by Stock Investor Journal.
Get data to assist you with your trading.
The return from the opening value of 5073 for the XJO S&P ASX 200 index on July 3, 2006 was 23.67%. The close value of the XJO index on June 29, 2007 was 6274. This is a 23.67 % return for 2006-2007. When we measure returns we use this as the benchmark zero line. We count only returns above this level. The 40% return shown in the first column is reduced to a real return of 16.33% once the return from the market is excluded. The 18% return from an investment or superannuation fund is reduced to a negative 5.67% return once the return from the market is excluded.
Aggressive and demanding investors will measure the market return from the low of 4899 to the high of 6409 is 30.8%. We keep this benchmark in reserve because it is only good luck and good fortune that allows traders to select both the top and bottom of the market. However, the returns available from the market fall somewhere between these two methods. The exact calculation method you choose to apply to the benchmark does not alter the assessment process.
Investors transfer capital to funds for many reasons. Compulsory superannuation is one. Convenience is another, because people believe they do not have the time to manage their investments. Others believe they do not have the skill. In all of these situations we are encouraged to believe that that the fees we pay is a recognition of the management skill of the fund manager. We believe we can reasonably expect that the skill from these professionals should be able to, at the very least, match the performance of the underlying market.
The bottom 25% of share funds in Australia returned a loss of 26.7% in the 2006-2007 year. These indicate a low valuation in terms of professional management skill, but the median return was – 0.4%. Similar results are likely to be experienced in other sectors of the fund management industry, including superannuation. It appears that the primary skill exercised by many fund managers is the ability to seriously under perform the market. The diagram shows the results.
At Guppytarders.com we use a much tougher and we believe, a more realistic measure of portfolio performance. Our benchmark is the average of the return available using the two market measurement methods. The 23.67% return 2006 open to 2007 close and the return from the 2006-07 low to the 2006-07 high. This gives a benchmark return of 23.67%. This sets the water line, the benchmark, the minimum return required from our activity in the market. Any return that is below this figure is simply under water.
How do we achieve this? We achieve this by active trading as illustrated in the case study examples in the newsletter. We achieve this by using an Exchange Traded Fund to passively track the market performance. We prefer to apply some entry and exit strategies to capture the broad trend movements and changes. In 2006-07 this was simple a buy and hold strategy.
The market is a tough place. We use it to grow our capital in the most effective way possible. When returns are above bank interest rates we are satisfied. When returns fall below the level available in market activity, we are not satisfied. We do not pay for the skill of under performing the market.
In coming weeks there will be many advertising claims about superior performance in difficult markets. It pays to really understanding bench market performance that is appropriate and then to assess these claims against the benchmark. The results will be surprising.
We started with a simple question. The Australian Financial Review reported that the top 25% of fund managers returned 30.5% in 2006-07. Is this a good return or an unacceptable return? This return is 6.83% better than the market. The result is a low return for management expertise. It is even lowered when management fees are taken into account.
Read more articles by Daryl Guppy.
Read more articles by Stock Investor Journal.
Get data to assist you with your trading.