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Investing
Measures to work out if your share portfolio is a success
Nick Renton AM - March 12, 2008
 The performance of listed companies is frequently discussed, often in the context of remuneration packages for executives and the performance hurdles required for these to exercise executive options.
The performance over a period such as one year of the share portfolios owned by individual investors is discussed less frequently. One reason for this is the difficulty of measuring investment performance objectively. Another is that such an exercise really produces interesting but quite useless information.
When the results are good the investors concerned congratulate themselves or their advisers. However, they get a misleading impression of their infallibility. In the reverse situation, all that they can do is get out their handkerchiefs and wipe away their tears - although possibly they can learn lessons as to how to do things better in the future.
A further matter to be considered is what yardstick should be used when looking at performance.
One way is to have regard to the absolute performance of the portfolio - effectively the answer to the question: "How much has my net worth increased?" This approach uses the philosophy of "absolute return" managed funds. Individuals and superannuation funds often postulate a target - for example, the consumer price index plus three percentage points. The higher the risks being run the higher the margin in the target rate needs to be.
Another way is to look at the relative performance: "How does my fund's outcome compare with that of a particular yardstick?" Relative performance is favoured by most managed funds managements, but this yardstick can lead to individuals saying things like: "We congratulate ourselves on having outperformed the All Ordinaries Index by 10 per cent. However, unfortunately our total wealth went down by 15 per cent."
The yardstick
The above raises the question of just what constitutes a suitable yardstick. For equity and growth portfolios the All Ordinaries Index or the S&P/ASX 200 Index can be used. The former is more suitable for diversified portfolios which include small capital stocks. The latter would be more suitable for portfolios which focus on the leaders.
Alternatively, one can use as a yardstick the performance of a listed investment company - for example, Australian Foundation Investment Company (AFI) or Argo Investments (ARG).
For fixed interest portfolios the returns can be compared with Commonwealth bond yields (which can be downloaded from the RBA website). Using published managed fund returns would be less suitable here, as many of these funds are active traders in fixed interest securities, whereas most individual investors are not.
The performance of these funds would include capital gains and capital losses from trading. Managed funds also involve fees. They would probably publish "after tax" returns, whereas individuals would usually look at their own returns on a "before tax" basis.
Investors with a mixture of equities and fixed interest investments (including cash) should probably look at these two components separately.
Another way to measure performance is to add the dividends received during the year to the end-of-year total market values (say), ignoring taxation and imputation credits. The result can then be benchmarked against an accumulation index.
Arithmetic
Finally, the question arises of how best to do the actual arithmetic when measuring portfolio performance.
A detailed explanation of this, together with a worked numerical example, will be set out in Part 2 of this article.
More articles from this week's newsletter:
Broker Watch: What brokers think about media stocks
Investing: Measures to work out if your share portfolio is a success or a failure
Resident Trader: Secrets for Profiting in Bull and Bear Markets
CFDs: How to trade CFDs without losing your shirt
Expert Panel (Futures): Using futures to pick the market direction
Rates: More banks go for big rate increases
Market: ASIC launches probe into market rumours
Property: House prices rise 12 per cent nationally
Takeovers: Incitec makes friendly bid for Dyno
Whatever your views, you can discuss this article - or any of Nick's articles - on our message board Your 2 Cents.
Nick Renton AM is the founder and first president of the Australian Shareholders' Association. He is a consulting actuary, commercial arbitrator, company director and writer. He is the author of 62 published books covering shares, property, managed investments, taxation, wills, the Internet and the Australian economy. He has written books about more different topics than any other Australian author. He was made a Member of the Order of Australia in 2004.
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