Portfolio Management Secrets of a Successful Investor
Investors Ask: How do I improve my investment performance?
We’re all familiar with the disclosure at the end of all the commercials and print ads: Past Performance Is No Guarantee of Future Results.
If that’s true, then how can you be sure that someone is doing better than the market? Well, the short answer is: You Can’t. But there are ways to compare managers based on the returns and the amount of risk used to get those results. There’s returns and then there’s this thing called “risk-adjusted returns.” The raw number of the returns produced by an investment manager don’t tell the whole story. What matters is how much risk did the manager take on to get that result.
It’s sort of like comparing two millionaires with the same amount of wealth: One got his by diligently operating his widget-making business and selling each widget for a profit. The other mortgaged his house, traveled to Atlantic City and placed all his money on #12 and after one-spin of the Roulette wheel hit the jackpot.
In investing this is because the Efficient Market Theory says that stock prices generally reflect all known information that is available. So this is the best argument for “index investing.” This is what has been advocated by John Bogle of Vanguard and is the basis of “Strategic Asset Allocation.”
Less than 50% of all active investment managers match or outperform their benchmarks over any given 3-year or 5-year period according to the Standard & Poor’s Indices Versus Active Funds (SPIVA) Scorecard, August 2011.
(Source: S&P Indices, CRSP. Outperformance is based upon equal weighted fund counts. All index returns used are total returns. Charts are provided for illustrative purposes.)
Let’s look at the following chart for illustration. Most investors when given a choice would prefer Red Line (Gross Return Before Fees of 1%) or the Green Line (net of fees) and avoid the kinds of losses incurred in the S&P 500 Index (Red Line).
But clearly as this chart illustrates, one portfolio managed in a certain way actually offered a better result with a smoother ride (fewer ups and downs) compared to the broad stock index. This kind of investment performance is based on the more dynamic approach of “Tactical Asset Allocation.” Using price momentum measures and actively changing the percentage allocated to any particular investment asset (stock, bond, mutual fund or ETF) based on these signals provides one way to protect principal or gains from downdrafts in the market.
So, Secret #1: Control for the Risk You’re Willing to Take
Now let’s take a look at “Risk.”