14/12: Mind the Gap Please
In the London Underground the trainmen can often be heard saying, “Mind the Gap Please”!
The Underground employees are not warning of a mountain passage or missing time on a taped recording. Rather they are alerting their riders to step over the space between the train and the platform. In short: “don’t fall down”.
This Blog is being written to urge you to mind the Gap – the performance gap in your investment program.
The situation is this: a given asset allocation has a minimum return available to every investor in any given year based upon investments in appropriate index funds. In our work doing risk/return reviews for religious investors we are discovering that many funds are under-performing what the market gives them - often by more than 2% a year! Losing 2% on a $10 million portfolio means $200,000 in lost income! Serious business.
Why does this happen? Most often it is a combination of high fees and equity managers who do not achieve their benchmarks. This is not surprising particularly over the longer term. In any given five year period something like 80% of equity managers will under-perform their benchmark. Likewise, a superior record over a five year period is a good predictor of under-performance in the next five years. These are painful facts that your advisor wishes you not to know. In other words the periodic selection of new managers based upon their recent excellence most often will lead to disappointment.
The passive or index approach has no such built in problem. Returns will always be close the benchmark return less any internal fees (often only 1/10th of 1 percent). In most portfolios, the important factor will be asset allocation. Studies have shown that asset allocation determines 90-100% of the outcome for investors, even large institutional investors.
An example will be useful here. In 2004 the participants in our Benchmark Survey of Faith Based Investors had average asset allocations like this:
35.0% large Cap US Stocks
16.5% small or mid cap US stocks
7.1% International stocks
32.7% Bonds (investment grade, high yield, International and TIPS)
6.1% Cash
2.6% Alternatives
In short the asset allocation was approximately 60% equity and 40% fixed income.
The return from this mix of assets, had they been invested in index funds, would have been 10.1%. Many of the portfolios we have examined undershoot this easily achieved target by 2-4%.
The question is why?
Mind the gap please. Earn the $200,000 or $400,000 or more that is needlessly left behind.
O. Sam Folin, CFA
December 14, 2005
The Underground employees are not warning of a mountain passage or missing time on a taped recording. Rather they are alerting their riders to step over the space between the train and the platform. In short: “don’t fall down”.
This Blog is being written to urge you to mind the Gap – the performance gap in your investment program.
The situation is this: a given asset allocation has a minimum return available to every investor in any given year based upon investments in appropriate index funds. In our work doing risk/return reviews for religious investors we are discovering that many funds are under-performing what the market gives them - often by more than 2% a year! Losing 2% on a $10 million portfolio means $200,000 in lost income! Serious business.
Why does this happen? Most often it is a combination of high fees and equity managers who do not achieve their benchmarks. This is not surprising particularly over the longer term. In any given five year period something like 80% of equity managers will under-perform their benchmark. Likewise, a superior record over a five year period is a good predictor of under-performance in the next five years. These are painful facts that your advisor wishes you not to know. In other words the periodic selection of new managers based upon their recent excellence most often will lead to disappointment.
The passive or index approach has no such built in problem. Returns will always be close the benchmark return less any internal fees (often only 1/10th of 1 percent). In most portfolios, the important factor will be asset allocation. Studies have shown that asset allocation determines 90-100% of the outcome for investors, even large institutional investors.
An example will be useful here. In 2004 the participants in our Benchmark Survey of Faith Based Investors had average asset allocations like this:
35.0% large Cap US Stocks
16.5% small or mid cap US stocks
7.1% International stocks
32.7% Bonds (investment grade, high yield, International and TIPS)
6.1% Cash
2.6% Alternatives
In short the asset allocation was approximately 60% equity and 40% fixed income.
The return from this mix of assets, had they been invested in index funds, would have been 10.1%. Many of the portfolios we have examined undershoot this easily achieved target by 2-4%.
The question is why?
Mind the gap please. Earn the $200,000 or $400,000 or more that is needlessly left behind.
O. Sam Folin, CFA
December 14, 2005
