Friday, August 14, 2009

Is it Time to Change the Benchmark?

One of the unfair facts of life for investment managers is that our clients insist on two different unofficial benchmarks for performance comparisons. In bear markets, when stock market values are plummeting, clients insist on comparing portfolio returns to cash. However, in bull markets, when stock prices are roaring ahead of other asset classes, clients want to change their benchmark and compare their returns to stocks. There is of course, nothing overly unreasonable about this state of affairs, at least in the eyes of our clients. Unfortunately, if you believe in managing risk by constructing diversified portfolios that own stocks, bonds and cash (and many other asset classes), you are virtually guaranteed to underperform cash in a bear market and underperform stocks in a bull market. This somewhat depressing state of affairs of having your portfolio underperform in both bull and bear market environments is the result of switching between two different benchmarks. We are seeing this unofficial “changing of the guard” with our clients’ perceptions occur now that the market rally is entering its 6th month.

Clients used to ask the question “how am I doin?” in the context of a massive bear market that took the S&P 500 Index down by 57% to its intraday low in early March. The market topped in October of 2007, and for the record it is still about 35% below its all-time high price. If you care to view performance in the context of the market top to current price, then our portfolio results of minus single digits are either very good compared to stocks, or very lousy compared to cash, where investors of all levels of experience can park their money without paying Pinnacle a fee. On the other hand, the stock market has rallied by 51% since the lows on March 9th, and the +25% gains in Pinnacle’s Dynamic Moderate Growth (DMG) portfolios look fantastic compared to cash, and pretty lousy compared to stocks, where investors of all levels of experience can park their money in an S&P 500 Index fund without paying Pinnacle a fee.

We continue to counsel our clients to view investment results over a complete market cycle. Once you take a step back and look at performance in a time horizon that includes both bear markets and bull markets, you can get a good perspective for how we are managing portfolio performance. Depending on time horizon, Pinnacle’s DMG portfolios have delivered between 200 basis points (two percent) and 600 basis points (six percent) of performance over and above our benchmarks, net of fees and transaction costs. This year we are having a phenomenal year relative to cash and a very good year relative to our blended benchmarks. In fact, at the moment most of our portfolios are beating the performance of the S&P 500 Index for the year to date period, which is entirely unexpected in a year where the S&P is delivering positive returns. However, we are trailing from the market bottom, which is entirely expected. So, “how are we doin?” It depends on your investment time horizon and what benchmark you care to use.