Made to measure

Some fund managers gloss over their funds' performance, as I discovered at a recent conference. They all briefly mentioned performance and that, on occasion, they managed their funds to an unconstrained benchmark; some noted that they had outperformed their relative benchmark. But little attention was paid to this aspect of the fund overall.

Given the tools discretionary fund managers (DFMs) have to compare the risk-adjusted returns of funds, this was not so important.

However, the lack of standardised performance has a meaningful impact on private clients, trustees and their advisers when considering if the returns of an investment portfolio have met the objective and mandate. Discussions around this topic are also relevant ?for advisers trying to assess the performance of DFMs.

Over the years, how to measure performance has turned into a minefield to circumnavigate. Is the portfolio performance on valuations measured by time-weighted performance? Are the figures gross or net of all costs or just net of some costs? Is it managed against an equity benchmark or models such as the Wealth Management Association (WMA), formerly known as the Association of Private Client Investment Managers and Stockbrokers, indices? ?The list goes on.

Because we as an industry have not standardised our approach, it is not surprising that fair analysis of this area has become more difficult for the adviser, private client and trustee to understand.

When assessing performance, ?one of the first aspects to determine ?is whether the portfolio is being managed on an absolute or relative benchmark basis. Arguably, a large number of DFMs will claim that they manage the portfolio on an absolute basis while, in practice, they are more conscious of relative performance.

This can be observed over time ?by seeing whether the DFM changes ?asset allocation away from, for instance ?an WMA benchmark, or if it remains ?in a tight band, closely replicating ?the benchmark.

Peer pressure

Another way to assess DFM performance is to analyse it against a peer group. A growing number of independent consultants have formed such benchmarks. However, the issue is whether a balanced performance for one DFM is really a ?like-for-like comparison with another.

Some professionals use an equity index to compare performance. This may provide a good talking point, but ?it will have little meaning unless you are a high-risk investor, especially if you are looking at a lower-risk profile with only limited equity exposure.

So, what is important when an adviser, private client or trustee analysing portfolio performance? Perhaps the principal aspect is whether it has it met the client's objective. If so, does any other measure matter? Indeed. Surely we should be looking at protecting the portfolio from taking on too much risk in trying to meet those objectives.

Even if the goal has been met, performance figures do not display clearly whether it has been achieved by taking on significant risk. Looking at the risk-adjusted returns and seeing what level of volatility a DFM had to take to achieve these returns is important.

Using a measurement of risk-adjusted returns, a true like-for-like comparison can be done in terms of the volatility and risk taken by different DFMs. Then it's clear what performance has been generated against different levels of risk taken.

Going forward, one trend to be encouraged in private client investment management, is advisers and clients being clearer on the volatility they will accept for a potential return. With the help of risk-adjusted performance reporting, DFMs are moving towards this.

Claire Bennison is regional director at Brooks Macdonald in Manchester

She writes a regular in-practice article on asset management for Private Client Adviser

This article was published in the November 2013 issue