Part 3: Portfolio Monitoring

This blog will be considered Part 3 of a 3-Part series pertaining to Portfolio Monitoring. Please view the Part 1 blog and Part 2 blog.

How Should You Measure The Success Of The Portfolio And Why Is It Important?

Throughout this series we’ve discussed how we monitor client portfolios after implementation.

In Part 1, I discussed how we view client portfolios as having layers like an onion comprised of asset classes, investment mandates and then individual securities. We also discussed how and when we monitor client portfolios including the triggers we have in place to flag a portfolio that is deemed to be “offside”. We also discussed the 5 factors we consider prior to rebalancing the portfolio.

In Part 2, my colleague Dan Hallett discussed how we monitor and evaluate manager performance.

In this final instalment I wanted to discuss HighView’s approach to portfolio performance monitoring and why measuring the absolute success of the portfolio is more important than relative success.

How does HighView measure success?

Ultimately, we are paid to design a wealth plan and execute the investment strategy that aligns with it, which includes the rate of return required to achieve the client’s objectives or funding obligations. While we believe that measuring relative success against industry benchmarks is important to a certain extent, the overall success of the portfolio boils down to a simple question: is the portfolio meeting the client’s funding obligations or not?

To emphasize how important this question is, let’s take a very simplified example. Say the client has a portfolio size of $2 million and the wealth plan shows that this client requires $100,000/year to fund their lifestyle needs – this means we need a 5% rate of return in order to fund this client’s lifestyle obligations while also protecting the principal (ignoring the impact of inflation in this example). Anything less than this 5% return would not only fail to meet the client’s funding obligations, but also erode the principal investment (ie. the value would drop below $2 million after we withdraw the $100,000) and make this annual funding obligation more difficult to achieve going forward since we now need more than a 5% return next year to get back “on track”.

Whether the investment mandates are outperforming their appropriate benchmark is far less important than if the funding obligations are being met or not. In fact, given that this is the only metric that truly matters to the client it is ultimately used to determine how well we are doing our jobs.

What is the point of celebrating relative performance if you do not meet your funding obligations? Theoretically, we could have 7 investment mandates that outperform their appropriate benchmark, while 3 miss their mark. Using the above example, if we are still unable to achieve the 5% target rate of return the client needs, then we shouldn’t be patting ourselves on the back.

What is HighView’s approach to performance reporting?

Many clients receive their monthly/quarterly account statements from their bank or custodian and may only see the market value change from one month/quarter to the other as well as the holdings and transactions during that period.

Unfortunately, these values do not tell the full story, which can sometimes lead to unnecessary panic or frustration when the client sees the market value of their portfolio decline compared to their previous report. Regrettably, most people don’t fully see each of the components that go into a proper performance report because it’s not the “industry standard”.

While we do provide clients with individual manager and mandate performance against appropriate benchmarks the more important metric is the absolute performance of each individual account and the portfolio as a whole (ie. the client’s $100,000 funding obligation or 5% target rate of return).

Additionally, we believe that the client’s portfolio should be managed just like a family business and so we structure our performance reporting similarly to an Income Statement, which includes a transparent breakdown of all income vs. expenses.

We provide our clients with their complete return composition (in $ and % terms) at both the combined/total portfolio level and for each individual account that makes up their portfolio:

1. Beginning Value
2. Net Contributions
3. Income Received
   • Interest
   • Dividends & Distributions
4. Expenses Incurred
   • Custody Fees
   • Management + Advisement Fees
   • Transaction Costs
   • Taxes
5. Net Cash Income Received
6. Change in Market Value of Investments
7. Ending Value
8. Net Return (in both $ and % terms)

We calculate performance using the Dollar-Weighted or Internal Rate of Return (IRR) method, which factors in the timing and size of portfolio contributions/withdrawals and provides a more meaningful measurement of portfolio performance.

Our performance reports include total return values for the most recent quarter, year-to-date, 1-year, 2-year, 3-year, 5-year and since inception. This allows us to track the absolute performance of the portfolio over time.

Why is this reporting approach important and how much insight does it provide?

This reporting approach is important for the following reasons:

1. It provides a fully transparent and digestible breakdown of how we arrived at the net return values vs. simply providing the client with a beginning value, ending value, and a return in % terms only.
2. It allows the client to have a better understanding of the portfolio’s performance over a longer period of time vs. a single snapshot of a relatively short time period.
   • Which mandates are adding value over time and contributing to the absolute return target (ie. the target rate of return)?
   • How has the investment strategy fared against their absolute return target and is the client still “on track” with their wealth plan and stated objectives/funding obligations.
   • Is the current investment strategy working well or is performance lagging behind the target rate of return?
3. Life ebbs and flows, which means the client’s wealth plan and portfolio structure could too. These performance insights allow us to have open conversations with our clients while periodically revisiting the portfolio structure.
   • Have there been any life changes that could have a material impact on the wealth plan, target rate of return, investments strategy and portfolio structure?
   • We can make any necessary portfolio structure changes to improve the probability of meeting the target rate of return and ultimately the client’s stated objectives within the wealth plan. However, sometimes the best investment decision made is to do nothing.

To recap, performance monitoring and reporting is the final step of the “portfolio monitoring” process and is critically important to determine whether or not the investment advisor you hired is adding value.

There are some things in our measurement-obsessed world that simply cannot be measured, but portfolio performance happens to be one of those things that can be. For that reason, the old adage, “If you can’t measure it you can’t manage it” is especially true in this case and it is important to our firm and the clients we serve.

Monitoring and reporting the portfolio performance relative to a client’s unique return requirements is the best way to measure overall success because you are either meeting the client’s funding obligations, or you are not.

If our approach is something that you feel would be a good fit, we welcome the opportunity to have a conversation with you.

Please view the Part 1 and Part 2 blogs.