Is your financial advisor delivering what you expect? And, why you need to be abreast with the technique of benchmarking.
Many advisory firms select a broad-spectrum index, like the Sensex, as a benchmark to highlight the performance of their product and knowingly or unknowingly lull you into a false sense of confidence. What they are doing is but natural, showcasing their product in the best light. But this does not stop you from applying the principle of caveat emptor, buyer beware, by selecting and applying your own benchmark, depending upon your purpose and expectation from that investment.
A relative benchmark is the targeted or desired return on investment, based on the variable return from indices, listed funds, government securities, commodity prices, etc. Relative benchmarks are appropriate for short and medium-term performance review, and the same principles can also be used to evaluate a product or advisor's historic performance before you invest. But you may ask, what’s the best way to do this?
Since you need to evaluate performance of all your liquid and illiquid investments, you need to start by consolidating all financial transactions in one place. In other words, you need to use a software tool that allows you to upload data and run analytics that help you understand, oversee and evaluate your advisor’s recommendations on your investments. Family offices and even individual investors that have already started walking this path, are deriving a lot of value from cloud based software platforms. The top 3 advantages are elaborated upon below:
Sharper understanding of the asset mix
Identify whether the advisor represents single or multiple asset classes. For example, an advisor for equity investment represents a single asset class. In that case you expect the advisor to add value through Security Selection- choosing stocks that outperform the equity market, so that your portfolio does better than other securities in that asset class.
Alternatively the investment plan may be broader, allowing the advisor to invest in debt and equity, i.e. multiple asset classes. Now the advisor is expected to add value through Asset Allocation & Manager Selection- allocating and shifting funds over multiple portfolio managers across multiple asset classes, changing the debt-equity mix, depending on best corresponding returns. By default he will also be responsible for security selection in order to create returns within each asset class.Select The Benchmark Index Best Suited For The Investment
With tools that allow you to see sector allocation, you can select relevant benchmarks, including small-cap or mid-cap indices that mirror your investment profile. A list of Bombay Stock Exchange (BSE) indices is available here to help you select the benchmark that best suits your investment profile.
Also consider the time horizon while selecting a benchmark. For example, when it comes to evaluating fixed income, benchmarking short-term commercial paper against long-term government securities does not provide a comparative term or risk profile. Instead, corporate bonds of a similar duration would be a more appropriate benchmark. Use this process to select multiple benchmark indices, with each benchmark representing a corresponding investment tranche or asset class.
Understand weighted average benchmarks
Most families have a fair idea of their desired asset-mix based on a family risk profile. Although your advisor has the freedom and flexibility to alter this mix within the portfolio handled by them, you can calculate a comparative performance based on your ideal asset-mix, using weighted average benchmarks.
In the example, your desired debt-equity mix is 20:80, or Two Lac Rupees and Eight lac Rupees in the total investment of INR Ten Lacs. The investment amount multiplied by the relative benchmark return gives you the weighted average target. Comparing the target to the year to date investment value, the advisor has outperformed his benchmark in equity and underperformed in debt. But the key take away is that he has outperformed his total weighted average target by 3.5%.
You can measure advisor performance even if you do not have a break-up of asset classes. Simply calculate the weighted average target as per your target mix and compare its total with the total investment value. Using this method, you can analyse the comparative returns from multiple advisors across different products and asset classes.
Relative benchmarks based on indices and commodity prices are excellent tools for the short-term. However, they do not shed light on whether your overall portfolio is achieving the target of maintaining and growing your long-term wealth. In 2013, gold prices fell over twenty-seven percent. Would you have been happy that your relative benchmark was exceeded, when your bottom line showed capital erosion?
That is where an absolute benchmark comes in. For many, setting long-term financial targets stems from practical necessities like buying a house, funding children's education, retirement nest eggs or supplementary income post-retirement. Individuals contributing to a corporate or private pension plan have already set them some absolute benchmarks based on expectancy of future spending.
Benchmarking, as described above, can be a complex exercise, especially if you have a large portfolio spread across multiple product categories and asset classes. It is prudent to therefore rely on software that can not only accurately measure your portfolio performance but also allow you to compare against your choice of relative and absolute benchmarks.
In summary, use relative benchmarks to evaluate financial products and determine whether your financial advisor is meeting short and medium-term target expectations. Alongside, keep one eye on the future, with an absolute benchmark to monitor how your wealth survives long-term economic turbulence. More importantly embrace new technology platforms that allow you to access and monitor your investments on demand and ensure you have updated information when you need it. Make smarter investment decisions with your financial advisor by understanding benchmarks and applying them across the breadth of your portfolio.(The writer is Executive Director at Asset Vantage)