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Moneyfarm’s portfolios explained: how we measure performance

In this Investment Strategy series, we’ve covered everything from the key tenets of our investment philosophy to the structures we put in place to govern them. This fifth and final instalment will focus on what we do after the portfolios have been constructed: how we assess our performance. 

There are five key levels at which Moneyfarm’s portfolios can be evaluated: 

  • Absolute return;
  • Portfolio return versus peers;
  • Portfolio return versus benchmark;
  • Effectiveness of the investment process
  • Ex-post risk analysis

Here, we’ll give a brief overview of each one and how it ties into our wider performance analysis. For the full breakdown of each stage and more detail on the process as a whole, check out our full investment strategy document here

Absolute return evaluation

We start by evaluating the absolute return of our portfolios – meaning that we don’t, at this stage, compare the portfolio to any benchmark or peers. This is simply about how our portfolios have performed insolation. There are three key tenets to this: monitor, review, and analyse. 

  • We monitor the performance of our model portfolios on a daily basis – considering risk metrics as well as returns;
  • We review the performance of clients’ portfolios at our monthly Investment Committee meetings;
  • We analyse ex-post the contribution of each asset class and ETF to the returns of our portfolio, to understand what exposure impacted performance either positively or negatively.

Returns versus peers

Perhaps more relevant for a lot of investors is how Moneyfarm performs relative to its peers. Ultimately, people invest to see their wealth grow and they want to know that their savings are in the right place. There are two key groups against which we compare the returns of our portfolios:

Internal Peer Groups

We have built internal peer groups of mutual funds (using Bloomberg data), against which we compare ourselves in both the UK and Italy. There are a couple of advantages here: Firstly, we have greater clarity on the performance of individual funds. Secondly, with daily data we have a better sense of peer portfolio volatility, compared to seeing only monthly returns. 

ARC Private Client Indices (PCI)

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Our clients have a wide choice of managers and we want to understand how we perform in comparison. We subscribe to ARC PCI – a peer group comparison tool that tracks the performance of discretionary private client portfolio managers. 

ARC has four different risk levels: Cautious, Balanced, Steady Growth and Equity Risk. We match these four to each of our risk levels and track their performance on a monthly basis. We focus not just on absolute return, but also on risk metrics like volatility and drawdown.

Portfolio returns versus benchmark

When we put together our portfolios, we think about long-term absolute returns – helping clients to grow their wealth over time in real terms. So, we think it makes sense to have benchmarks that reflect that underlying philosophy. 

There is a challenge with this approach – these portfolios cannot ‘go short’, so it’s tough to generate positive returns from falling markets, especially in the very short term. Historically, this issue has been addressed by focusing on long term returns. We compare the performance with Xibor (interbank deposit interest rate) plus spread. The spread is aimed to repay the risk underlying the portfolios. 

Measuring our tactical choices

How do we know if the Tactical Asset Allocation process is effective? We have several ways of evaluating this. Some of the measures are strictly related to the objective of the tactical choice, i.e. improving risk-adjusted expected returns. Others are absolute measures to understand the quality of the portfolio relative to peers. The primary evaluations we perform are:

  • We track the impact of individual rebalances or a group of rebalances relative to a baseline date.
  • We evaluate the performance of the Investment Committee – was the decision-making process valuable? Did we miss signals that we should have followed?
  • We compare the performance of our portfolios versus the Strategic Asset Allocation, with a particular focus on risk-adjusted returns.

Ex-post risk analysis

As for the ex-post return, we monitor the risk measure of our portfolios in the following ways:

  • Volatility: We check that the ex-post volatility remains within the target range.
  • Drawdown: Maximum drawdown is an indicator of downside risk over a specified time period. A maximum drawdown is the maximum observed loss from the peak of the portfolio to the minimum reached.
  • Volatility contribution: Decomposition of the volatility among risk factors or ETFs. It considers both the overall risk and the diversification effect of the asset class inside the portfolio. The volatility contribution isa useful tool in understanding what the greatest risk contributor is and to understand if the market risk is too concentrated on a single risk factor.

The ex-post analysis is an important part of analysing the effectiveness of our tactical choices. It establishes whether or not we are able to track our target risk or to contain the drawdown of the portfolio. We can, also, understand if the volatility of the risk factor has started changing and what is driving the movement of the portfolios. We also want to analyse any losses, comparing them with our ex-ante expectations in order to understand if our estimates correctly accounted for the risk in the portfolios.

So, there you have it, our simplified five part investment strategy process. Again, if you want to take a look at the full document, which is stacked with plenty more detail on everything we’ve discussed in these five posts, feel free to download the full document here

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