Showing posts with label relative return investing. Show all posts
Showing posts with label relative return investing. Show all posts

Tuesday 7 January 2020

What is a relative-performance orientation?

Relative performance involves measuring investment results, not against an absolute standard, but against broad stock market indices, such as the Dow Jones Industrial Average or Standard & Poor's 500 Index, or against other investors' results.

Most institutional investors measure their success or failure in terms of relative performance.

Money managers motivated to outperform an index or a peer group of managers may lose sight of whether their investments are attractive or even sensible in an absolute sense.



Who is to blame for this short-term investment focus? 

Is it the fault of managers who believe clients want good short-term performance regardless of the level of risk or the impossibility of the task? 

Or is it the fault of clients who, in fact, do switch money managers with some frequency? 

There is ample blame for both to share.



There are NO winners in the short-term, relative-performance derby. 

Attempting to outperform the market in the short run is futile since near-term stock and bond price fluctuations are random and because an extraordinary amount of energy and talent is already being applied to that objective. 

The effort only distracts a money manager from finding and acting on sound long-term opportunities as he or she channels resources into what is essentially an unwinnable game. 

  • As a result, the clients experience mediocre performance.  
  • The overall economy is also deprived, as funds are allocated to short-term trading rather than long-term investments.  
  • Only brokers benefit from the high level of activity.



Institutional investors should strive to achieve good absolute returns.

Institutional investment process should focus on maximizing returns under reasonable risk constraints.  

If more institutional investors strove to achieve good absolute rather than relative returns, the stock market would be less prone to overvaluation and market fads would less likely be carried to excess.  Investments would only be made when they presented a compelling opportunity and not simply to keep up with the herd.

Sunday 1 July 2018

The true measure of a successful investor

The true measure of a successful investor is not a comparison of performance against a stated index, but rather how well a portfolio performs during down markets.


Warren Buffett is unique in measuring himself annually against changes in book value (the simple calculation of assets minus liabilities).  He then compares this annual percentage against the S&P 500 with dividends to determine if he has added value or not. 

Buffett has not only added value.  He has done the remarkable.  Buyiing earnings of companies at attractive prices with outstanding management and with remarkable competitive advantages have all led to mind-blogging increases in book value.

A metric that Warren Buffett never reports or comments on is the actual market price of his stock.  He reports the value of his business because he can control purchases, ongoing management, asset purchases and sales, liabilities, and other things that affect changes in book value.  Conversely, he ignores the share price because often it has nothing to do with what is going on inside the business.

Value is inside.  Price is outside.

Friday 28 April 2017

Return Objectives

Absolute return objectives sate the percentage return desired by the client.  The return may be expressed on a real or nominal basis.

Relative return objectives express the required return relative to a stated benchmark.  A good benchmark should be investable i.e., an investor should be able to replicate it.

The return objective may be stated before or after fees and on a pre- or post-tax bais.

It could also be expressed in terms of a required return, that is, the amount an investor needs to earn over the investment horizon to meet a specified future goal.

The portfolio manager must ensure that the client's return objective is realistic in light of her tolerance for risk




Saturday 11 June 2011

Different strategies for investing available cash. WHY KEEP CASH?

Absolute and relative performance orientation.

One significant difference between an absolute- and relative performance orientation is evident in the different strategies for investing available cash.

Relative-performance-oriented investors will typically choose to be fully invested at all times, since cash balances would likely cause them to lag behind a rising market.  Since the goal is at least to match and optimally be at the market, any cash that is not promptly spent on specific investments must nevertheless be invested in a market-related index.


Absolute-performance-oriented investors, by contrast, are willing to hold cash reserves when no bargains are available.

1.  Cash is liquid and provides a modest, sometimes attractive nominal return, usually above the rate of inflation.
2.  The liquidity of cash affords flexibility, for it can quickly be channeled into other investment outlets with minimal transaction costs.
3.  Finally, unlike any other holding, cash does not involve any risk of incurring opportunity cost (losses from the inability to take advantage of future bargains) since it does not drop in value during market declines.

Friday 4 June 2010

Absolute Return Investing

At the other extreme, there are funds that are not benchmarked.  Instead, their objective is to target a particular return with a given risk level and a strong focus on capital preservation.  This strategy is called "absolute return investing" and is largely adopted by hedged funds.

Absolute return managers can invest in any asset class anywhere in the world.  Therefore, if the S&P 500 is falling significantly, absolute return managers can choose to allocate their money to a more favourable market like Europe and Asia, or even raise cash, to invest in another asset classes or invest short.

In a bull market, absolute return portfolios can under-perform against relative return portfolios.  However, in the longer term when markets go through the cycle of boom and bust, absolute return portfolios tend to outperform as big losses are avoided during the bear periods.

Benchmark Investing: Relative Return Investment Strategy

Fund managers who track a benchmark closely have a relative return investment strategy.

Their asset allocation strategy and stocks picked are close to their chosen benchmarks.  They then value-add by overweighting or underweighting stocks that they feel would help the fund outperform.

Investors who question the existence of fund managers, who consistently underperform their benchmark, have been advised to invest via index funds instead as they charge lower on management fees.

There are also managers who vary quite significantly from their benchmark.  With a larger tracking error, they can outperform it by quite a wide margin especially in volatile times.

However, when a broad based market heads south significantly, a fund that is benchmarked, like the S&P 500, will usually find it difficult to avoid losses.  
  • Firstly, this is because the fund is mandated to stay invested in stock under the index.
  • Secondly, the fund manager cannot stay invested in only a few profitable stocks, as they typically do not invest more than 5 percent of their portfolio in a stock or a group of related companies.