There is a jingle in one of the television stations in the USA that reminds me, at the end of each month or quarter and year, to find out where my investments are. The Jingle goes like this, “It is 10 pm; do you know where your children are?” That question gets asked every night, seconds before the 10 pm local news. Even comedians, musicians and movie producers/writers have used and continue to use that question in their lines of comedy, music or movie to emphasize one need or the other.
Actually, that question became important and needful following the urban unrest and rioting in the USA in the summer of 1967. It was the then director of Air Promotions at the New York’s WNEW-TV that coined that phrase to remind parents to keep an eye on their kids by keeping them off the streets. Since 1967, times have changed. Yet, that phrase is as important and needful in 2019 as it was in 1967.
Indeed, nowhere is this question most important than in investment performance measurement, where investors should be asked, “It is the end of the month, (the quarter or the year), do you know where your investments are?” The phrase can be used as often as possible, as a reminder to check investment performance on a weekly, monthly, quarterly or yearly frequency.
What is investment performance?
Investment performance is best understood after understanding what an investment is. Simply put, investment is the initial forfeiture of something of value, now, in exchange for the anticipated benefit of getting back more than what was forfeited. The difference between what was forfeited or put in, and what is gotten back, (the anticipated benefit), is the return on investment.
Performance measurement, therefore, is the technique or method by which an investor quantifies how much return he or she earned. Depending on the extent, it may also include quantification of how the return was made (attribution analysis) and what risks were taken to generate such returns.
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Why Measure Investment Performance?
Investors invest with an objective and strategy. So there is need to purse and check if the objectives are being realised and also if the strategy designed for the achievement of the objectives is working. Therefore, the need for investment performance measurement arises so as to-
Monitor Progress: Investment performance measurement helps investors to monitor the process towards set investment objectives with a view to either modify the objectives or modify the strategies to get to the objectives. For example, if you are saving or investing for your retirement, investment performance measurement will help you compare your returns against the projected future asset value required for your retirement. If the rate at which you are saving and the return you are getting will not lead to the accumulation of sufficient amount at retirement, it then calls for either increasing your savings rate and/or changing your asset allocation or investment strategy.
The potential cost of having an underfunded retirement asset makes investment performance measurement even more important. It helps you answer the quest, “am I there yet”, if not, “how far away am I”, if too far from your investment destination, it helps to answer the question, “will I get there at the rate I am going”.
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Asset Selection/Allocation: Investment, especially capital market investments, involves putting your money in different asset classes and types. Different assets have different characteristics and behave differently. Also, different assets yield different returns. Investment performance measurement, therefore, helps you to find out how much returns, different asset classes/types are making with a view to reallocating your assets or carrying out a rebalancing of your portfolio.
It is always good for investors to use the proper savings, spending, and asset allocation strategies that will provide them with the highest probability of reaching their investment goals with an acceptable level of risk. Unfortunately, market dynamics keep changing and as such, the decision on asset allocation needs to change in line with changing market conditions.
Investment performance measurement helps to find out what needs to be changed with respect to asset allocation strategies. For example, if you have a portfolio that is 80% invested in fixed income securities and 20% in equities because interest rates were over the roof, and over time, yields begin to fall while equity markets begin to pick up, you will be able to find out if the return you are making from your fixed income securities are lagging the return from equities through performance measurement, and then, you can decide to reallocate slightly away from fixed income to equities, maybe in a 50-50 or 60-40 asset allocation ratio.
Manager Selection: Due to the complexities in stock market investments and the complex nature of the instruments traded therein, most stock market investments are not on DIY (do it yourself) basis. Many investors invest through fund managers. Investors should select fund managers with a proven track record of successfully managing funds with positive returns.
Performance measurement provides the data needed to uncover managers’ track records. It does not end there, though, because, once you have selected a manager based on the track records uncovered by investment performance measurement, among other selection criteria, the managers’ performance needs to be reviewed and measure in an ongoing basis so as to know whether to retain such a manager or to fire him, investment performance measurement acts as a tool for periodic manager assessment.
Investment performance measurement comes very handy if an investor is investing with more than one fund manager as such measurement could provide a good yardstick for comparing between or among fund managers, especially when an investor wants to allocate more funds to fund managers.
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Past Performance does not Guarantee Future Performance
There has always been the phrase, “past performance does not guarantee future performance”, agreed, performance measurement is backward looking but the results derived from such measurement help to inform and shape investors’ forward-looking decisions.
But is not that simple…
Investment performance measurement is not as easy as that but it is an important tool in the hands of investors. It is not easy because it requires data and analysis, which may be quite involved if you want to dig deeper and if the data are not readily available. In my next article, I will detail the “how” of investment performance measurement because this piece has dwelt only on the “why” of investment performance measurement.
