When having a conversation about investment performance, the first thing I ask the other person is “what type of risk did you take to get that return?” It is “risk”, first and foremost, that really matters and is what drives risk-adjusted returns.
“Risk” is commonly referred to as Volatility and is measured by Standard Deviation, or, how much those returns deviate from the mean average. The more risk, the more volatility there is in returns.
Our goal as investors (and our #1 goal at High Rock) is to get the most return we can while limiting the risk we take to create those returns. This is commonly called the Sharpe Ratio and is most easily defined as Return per Unit of Risk. IE, how much Return did you make for every unit of Risk that you took. We want this ratio to be as high as possible. Without getting more complicated, let’s bring it back to the watercooler talk. So what if you were 100% invested in SP/TSX stocks for 2021 and you were happy with being up 8% on the year. At the surface, that sounds like a pretty good return, but is it? Nope, it isn’t. Why? Because the SP/TSX equity index was +24.4% on the year. Think about that from a risk perspective…you took all that equity risk and were only +8% on the year, while the market itself was +24.4% on the year. That type of return/unit of risk would be commonly classified as a massive “underperformance”.
Now what if you were invested in a balanced mandate (a combination of stocks, gov’t bonds, corp bonds etc.), as most of our High Rock clients are. The first thing to note is that it is not reasonable/fair/correct, to compare the performance of a balanced mandate to a single stock market index because a balanced mandate has far less inherent risk in it than an equity mandate (IE an equity mandate will have greater upside/downside than a balanced mandate…IE more risk/more return). For instance, it is not correct to say “hey, I was only +10% in my balanced mandate while the SP/TSX was +24.4% for the year”. Not an apples-to-apples comparison. What you need to do is compare your balanced mandate performance to other balance mandates (which we do internally with a large select balanced global mutual fund). We need to compare apples-to-apples, as best we can.
So the next time someone says they made X, Y or Z% last year, ask them what they were invested in (IE what type of risk they took) to create that type of return. It is the risk (the volatility of those returns) that really matters. As we say at High Rock, “we manage risk first and foremost and returns are the result of well managed risk”.
Apples-to-Apples
*Past performance is not an indication or guarantee of future performance. All numbers are for illustrative purposes only and are not representative of any particular account or mandate.*