Benchmarking Performances

Posted by Ethical Investing NZ

Thursday 16 May 2024

You may have heard of “benchmarks”. These are basically target returns that an investment is measured against. They are crucial tools to enable you as an investor to ask the following key questions:

  1. Is my investment strategy delivering the long-term returns required to meet my core financial goal?
  2. Is my portfolio performing well?
  3. Are the individual funds in my portfolio performing well?

Below we provide an overview of the different benchmarks we and MyFiduciary use to address these different questions.

Meeting core financial goals

Your allocation to growth (risk) versus defensive (less risky) assets is a function of the long term return you require to meet your financial goals and spending needs. In general, three benchmarks are commonly used to for this long-term requirement:

I. A fixed return e.g. an expected long-term return of 7% net of fees. This expectation is calculated by estimating expected returns for all the asset types that you have funds in, then weighting these asset class returns by how much you have in each of these asset types over the long term (what we call your “strategic asset allocation” or SAA).

II. Cash + X% how much would we expect each asset type to return in the long term, compared to cash. For example, for a balanced portfolio we expect a 2.5% p.a. better than cash return over the longer term.

III. CPI inflation + X% – any portfolio should beat inflation over the long term, and X is simply how much we want that to be. For example, assuming inflation is 2% over the long term, we expect a balanced portfolio to do 4.5% better than inflation.

Which benchmark is used above usually depends on the type of investor:

  • For most charities and foundations, an “inflation + x%” benchmark makes sense because their aim is to maintain the inflation adjusted value of their portfolio after costs and making distributions and grants.
  • “Cash + X%” benchmarks are more often used by investors with relatively high spending needs whose focus is seeking to add value over and above holding cash.
  • In contrast, a long term expected return is most often used by investors building their portfolio to meet future spending needs.

As most of our clients know, we believe you should not look at short-term returns when making comparisons against benchmarks. Market ups and downs mean it is unrealistic for the benchmark to be met or exceeded every year. Instead, we recommend looking at the medium-term – a few years. A common industry practice is hence to compare the performance of a portfolio over rolling 3 to 5-year periods.


Benchmarks used to assess portfolio performances

As with assessing how a portfolio is meeting its long-term financial goals, different benchmarks can be used to assess how our portfolios are performing, with each giving different information. Below we outline the benchmarks we and MyFiduciary use to assess portfolio performances in our quarterly review processes:

I. Reference portfolio benchmark – Popularised in New Zealand by the NZ Superannuation Fund, this very simple benchmark comprises low-cost passive investment in global and NZ shares and bonds only, with weights corresponding to the growth versus defensive mix of a portfolio. Comparing this return to actual portfolio performances enables us to see whether the combination of our asset allocation and fund manager selection choices are adding value.

II. Strategic asset allocation (SAA) weighted benchmark – This is calculated from the benchmark returns for each asset class and their weights in a portfolio. The difference between this return and actual portfolio returns reflect the valueadd of our fund manager selections. In contrast, the difference between the Reference portfolio and SAA weighted benchmark returns let us know how our asset allocation choices are performing.

III. Peer group benchmark – MyFiduciary also compares performances of the portfolios we offer against a comparable ‘peer group’ average in the marketplace. Unfortunately, the data does not exist to enable us to compare performance of the portfolios we offer against portfolios that other adviser firms offer. This may be because we don’t know what’s in their portfolios, or ours being highly ethical simply don’t have any direct competitors. Instead, MyFiduciary uses the next best alternative, which is to compare performance of each portfolio we offer against KiwiSaver and other multi-asset class funds in the marketplace with a similar risk profile.

As with assessing performance against long term financial goals, the time horizon also matters here. We do not expect to add value every quarter, but we do aim to add value over a medium-term (3 to 5 year) time horizon. Any area where this is not occurring sets our agenda for further scrutiny and debate.


Benchmarks used to assess individual fund manager performances

MyFiduciary’s approach to benchmarking individual fund manager performances mirrors the approach they take to look at overall portfolio performance. They compare performance of each fund manager against an appropriate asset class benchmark, and a peer group of similar funds. Funds that fail to perform at least equal to peer group averages and their asset class benchmarks over the medium-term, are placed on ‘watch’ in MyFiduciary’s quarterly review process. Such a fund will likely be replaced if MyFiduciary doesn’t think that the fund manager can turn around the under-performance.

Got any questions?
Let’s chat.

Call 09 337 0997
or send us a message.