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How Would You Rate Your Investment Portfolio-content

by  Jeffrey R. Lippman, CFP, ChFC
on   May 4, 2016


Rating Your Investments


The 2015 hit movie “The Big Short” was a fascinating tale of how our capital markets operate which gave an intriguing look into the making of the 2008 credit crisis. The movie was not only entertaining but also illuminated the financial world with highlights on investing.

In the beginning of the movie, hedge fund manager Michael Burry (played by Christian Bale) identifies significant threats facing the mortgage industry and proceeds to take heavy positions in order to short the industry (via credit default swaps). The movie, in part, follows Bale’s character as he sustains heavy losses for his investors year after year until finally, in 2008, his big “Short” is realized with the default swaps producing astronomical returns. However, before his plan came to realization, many of his investors grew wary and disgruntled. Some left his fund. To those who stayed, some grudgingly, Michael wrote out a simple email expressing his success, “You’re welcome.”

If you work with a financial advisor (as opposed to a hedge fund manager), how familiar are you with your investment strategies?  How would you decide if your portfolio was succeeding or underperforming?


Analyzing Your Investment Return


The simplest way to analyze your portfolio would be to periodically review your rate of return. Of course, the rate of return is irrelevant unless the portfolio is calibrated to its risk. For example, in the past three years the S & P 500 index produced annual returns of 32.39% in 2013, 13.69 % in 2014, and 1.4% in 2015. An evaluation of your own return against these rates would be relevant only if compared against the same downside risk as the S & P 500 which dropped 37% in 2008.

It is unlikely, however, that your investments are correlated to any one market index. It is more likely that you diversify your investments to avoid missing potential opportunities in other asset classes such as emerging markets. In order to perform an apples to apples comparison, each of your investments should be reviewed against the performance of its correlating index. It is easy to recognize that an adequate review of a multi-asset portfolio cannot be established by simply looking at a total average rate of return of a portfolio.


Adjusting by Volatility


Adding further complication to a portfolio is the objective of the investments. Whether preparing for retirement income, saving for a new home, the specific objective holds less importance than the timeline for when the desired cash is required to meet the objective. A commonly held investment strategy is to reduce the volatility when nearing an objective to assure the cash needs are met. In this case, the focus on return is reduced in pursuit of consistency, which is often the reason for owning more conservative securities like investment grade bonds.

However, this not only often makes a portfolio more complex, but adds yet another dimension to consider. As investments with less volatility tend to be more consistent over shorter periods of time, any review of a multi-asset portfolio with varying volatility should consider when to analyze each security. In other words, an annual review of an investment grade bond may prove far more relevant than reviewing the annual performance of a biotech security (highly volatile sector).  Whether Michael Burry’s investors stayed or left his highly volatile hedge fund, I’m certain that this was a lesson they learned!


Adjusting by Investment Management


Depending upon what investments a financial advisor recommends, the degree to which a portfolio can be analyzed will vary. The easiest strategy to examine would be the use of passive funds (funds that are intended to track an index, i.e.,  Exchange Traded Funds). Not only do they operate at low expenses, but they typically reflect a near perfect parity of risk/return. Therefore, you would be unburdened from comparing to an index and unconcerned with volatility deviation for each security. The onus, then, would be for the advisor to pick the indices and their percentage of the portfolio.

Financial advisors often use some form of active management (i.e. mutual funds) to provide opportunity for a given security to outperform its index over a certain period of time. Some funds attempt to beat its index when the index is up while others might offer better shelter if a particular index is down. Whereas active managers tend to operate within a certain philosophy (i.e. mid cap growth stocks), they often have the flexibility to blend between more than one index. Invariably, this can make an analysis even harder to make.

In addition, active managers will overweight one security over another because of specific inefficiencies they see within their field of specialty. For example, a financial sector active manager may stay away from large banks while overweighing say insurance companies because of a perceived long term threat to rising interest rates. Though this is the type of insight you would want from an active manager, it often goes without the promise of a specific timeline. This was akin to Michael foreseeing the housing market was doomed while his fund sustained losses unnerving his wary investors.




As I am sure you realize, the goal of this article is to reflect the challenges of analyzing an investment portfolio and potential threats that result from inadequate analysis. What can look bad might be good and what is good could be doomed to fail.  Time is usually the differentiator between these outcomes.

This does not mean that your portfolio (or advisor) should remain intact. However, when reviewing it, the focus should not be as much on the returns the investments accomplished, but on the understanding of why the investments are being selected and what goals they are expected to accomplish. Clarity between the two, I believe, will separate the achievers from the missed opportunities, similar to “The Big Short.”


Questions or comments? Email me at jlippman@capfin.net , call the office at 703-821-2000 ext. 212 , or get me on my cell phone at 301-704-2696 .

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The information is the personal views of Jeffrey Lippman and is not necessarily indicative of those of Capitol Financial Consultants, Inc. The information contained herein has been compiled from sources believed to be reliable; however, there is no guarantee of its accuracy or completeness. Any opinions expressed here are statements of judgment on this date and are subject to certain risks and uncertainties which could cause actual results to differ materially from those currently anticipated or projected.