Kristopher Heck (pictured above), Ian Thomas and Simon Glazier explain their process for picking an investment benchmark.
Kristopher Heck
Managing partner, Tanager Wealth Management
When choosing an investment benchmark, you need to be rules-based, clear and transparent. If you have a composite benchmark consisting of 13 components, you can probably tailor it to match your portfolio and that is disingenuous.
Create a simple rule
We use a 50/50 global benchmark, for example the FTSE All-World equity index as 50% and 50% of the Bloomberg Barclays Global Aggregate index. The criteria we like for a balanced portfolio is half of every stock and half of every bond in the world, which is easy to explain. It provides a good rule of thumb and means we are not manipulating the underlying components to suit our agenda.
If a client has an aggressive portfolio, we might do a split of 80% stocks and 20% bonds. We do not use Asset Risk Consultants (ARC) or Wealth Management Association (WMA) benchmarks because they have seven or eight components and different weights.
If there is a big event in the UK, an ARC or WMA benchmark might say you were up 8% in sterling. But it could be that others were up 18% in US dollars but you were hugely overweight on the pound, so it is a bad benchmark reflecting a bad portfolio.
Do your homework
We get our data from Morningstar’s Office portfolio management system. It makes sense for a firm that is just starting out, for example, if it does not have Morningstar or FE Analytics license.
Ian Thomas
Managing director, Pilot Financial Planning
A number of planners use inflation as a benchmark to present real asset value to a client’s wealth over time. That is a cop out. If invested in real assets over the long term, you would expect to beat inflation, so how can an adviser know they are adding value in terms of investment management and not just through financial planning?
Use something accessible
We want a starting point that is widely available. We need to get hold of it and understand it so we can report against it. It also needs to be relevant to the objective and portfolio we have built for the client.
We characterise asset mix as either growth or defensive. Equities go in the growth bucket and bonds and cash in the defensive. We have a centralised investment proposition where we have several portfolios that fit into one or the other.
Each one is benchmarked against two indices: the Investment Association Mixed Investment 20%-60% and 40%-85% sectors, and the appropriate ARC Private Client Indices index. We decided against a ‘composite benchmark’ as it is difficult to put together and not as accessible for clients.
Keep track
We use Nucleus’ reporting tool and FE Analytics. FE is useful for research but less so for reporting. Looking at portfolios, it is difficult to track the net of all the various fees. Also, new bits of money sit in cash for a few days before being invested.
Nucleus’ reporting gives us a true time-weighted and money-weighted investment return that allows clients to see the true value of their portfolio.
Simon Glazier
Head of wealth services, AAB Wealth
We have two different approaches: one system of benchmarking to help clients track their portfolios, and one we use behind the scenes to monitor individual fund performance.
Separate the benchmarks
For clients we think in terms of lifetime cashflow forecasts and benchmark on an ‘inflation plus’ basis. We have 11 core portfolios, graded from 0% in equities to 100%, in 10% increments. For every 10% increase in equity holdings we add 0.5% to the benchmark, so ‘Inflation +0%’ through to ‘Inflation +5%’. We are trying to reflect the expected long-term average real growth, after charges.
Behind the scenes we use a composite benchmark as part of our investment committee due diligence. Each fund has its own benchmark index, so we create a portfolio of benchmarks for each of the 11 portfolios. This allows us to monitor whether funds are achieving their own benchmarks.
Clients cannot relate to the fund benchmarks as easily as an ‘inflation plus’ figure, but we track portfolio performance using both measures.
Set targets
We came up with our inflation-based benchmark while working with Tim Hale, managing director of Albion Strategic Consulting. We looked at the expected returns of each portfolio after inflation and saw the increment was around 0.5%. So a portfolio with 20% in equity targets ‘inflation plus 1%’ and an 80% equity portfolio targets ‘inflation plus 4%’. This gives a ‘real’ number to compare performance with, and helps project future growth rates.
THREE TOP TIPS
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Kristopher Heck: Using a composite benchmark with clients is unclear and could let firms cheat.
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Ian Thomas: Keep track of costs as well as headline growth.
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Simon Glazier: Consider a two-tier system: one for clients and one for the firm.