Welcome to our series on Common Performance Questions. In this series Joe Porter, Orion’s Product Manager of Composites and Performance, will detail how to correctly read Orion performance reports and help you understand the various performance reporting methods available in Orion, all to help you have better conversations with your clients. Today’s entry looks at the question “Why is my portfolio performance lower than each individual asset in my portfolio?”
“Everything should be made as simple as possible, but not simpler.” – Albert Einstein
I won’t claim to be Einstein in regards to performance reporting, and I can’t even verify if this Internet-provided quote was truly said by the man himself or not, but I can say that the sentiment of this quote illustrates the purpose of our “Common Performance Questions” series.
We want to take questions that may seem complex, and break them down so they’re simple to understand without losing the ability to understand how we got there.
There are times when the overall performance return of an account can be higher—or lower—than all of the individual assets within that account. You can also see this type of situation at other portfolio levels as well, such as when household performance is higher or lower than all of the individual accounts in that household.
In today’s article, we will demonstrate how time-weighted return performance reporting can occasionally yield counter-intuitive results between levels in a given portfolio, and why you might see this type of apparent discrepancy.
Why is my portfolio performance lower than each individual asset?
I am going to start with a simple example that will allow us to answer the question of “Why is my portfolio performance lower than each individual asset?”
The following example can be used to explain the same question for any other level in a portfolio—such as differences between household, registration, asset class, etc.
A portfolio owns one asset, which makes up 100% of the portfolio at the beginning of the month. From the beginning of the month to the middle of the month the asset drops -10%, which is also the portfolio performance since there is only one asset in the portfolio at the time.
Asset 1 period return = -10% (100% of portfolio value)
Portfolio total return = -10%
On the 15th the portfolio purchases a second asset, which makes up 80% of the portfolio value.
Therefore, Asset 1 now makes up 20% of the portfolio value. From the 15th to the 31st Asset 1 is up +20% and Asset 2 is up +5% which brings the portfolio total return to -2.8%.
Asset 1 period return = +20% (20% of portfolio value)
Asset 2 period return = +5% (80% of portfolio value)
Asset 1 total return = +8%
Asset 2 total return = +5%
Portfolio total return = -2.8%
As you can see, the two assets’ total return is greater than the portfolio total return due to the portfolio not owning both assets for the full time period. If the two assets were owned for the full time period, however, we would then expect the portfolio return to be between the two assets.
A Real World Example
Next I would like to show a real world situation.
In the example below, you can see how owning assets at different times can yield an asset class total return that is higher than all of the assets that were owned.
Only three assets were owned from 1/1 to 1/6 to make up a -2.83% for the asset class return.
Two of the assets sold, leaving one asset in the asset class from 1/7 to 2/26. During this time, the period return was +8.91%, which now makes the total asset class return +5.83%.
On 2/27 another asset is purchased. There are now two assets from 2/27 to 4/14 for a period return of +2.93%. The total return increases again to +8.93%.
A third asset is purchased on 4/15, and from 4/15 to 11/12 the period return is -8.02%. After all is said and done, the total return drops to +0.19%.
As you can see in the far right-hand column of the chart below, each individual asset had a negative total return, whereas the asset class itself ended positive.
Before we wrap up today, keep in mind that period returns will be between the high and the low, which we can see in the chart above.
Also, the larger the weight of an asset, the bigger impact it will have on overall performance. If two assets each make up 50% of a portfolio, then total performance would be in between the two assets. If one asset makes up 80% and the other comprises 20%, then the total performance would be closer to the asset that owns 80%.
As you can see from our examples, returns of individual assets may not necessarily be totally reflective of the entire portfolio’s time-weighted return. As always, if you have any questions about your Orion reports, please contact the SME Performance Team.