How Did Your Portfolio Perform?– Understanding Risk and Diversification

In competitive pursuits, there are established and transparent measurement systems to
determine not just performance but how performance is achieved. In professional sports,
a variety of statistics are used to compare individual and team performance. Everyone
from team managers to owners to bookies use these common statistics. And because the statistics don’t like, there is little doubt or debate about who is good and as important, why they are good.

But with investing, arguably the most competitive and highest stakes game on
earth, few understand the stats. Many who have accumulated sizeable nesteggs from a lifetime of work understand the RBIs and batting averages of their favorite baseball hero better than how their money manager is performing.

The most important element contributing to investment performance is risk. You just can’t evaluate performance without the context of risk. Many investment advisors sell returns, not “risk adjusted” returns. They’ll tell you about their favorite manager who “killed it,” but you’ll never hear that he did so by taking risks that could have led to your losing all of your money.

Evaluating performance without measuring the amount of risk taken is like looking
at a golf score without adjusting for a handicap. The most sophisticated endowments
and family offices rigorously monitor “risk adjusted” performance. They hire the best
money managers and monitor levels of risk. They understand how a manager achieved
his results as much as the results themselves.

If your strategy is to actively manage your portfolio, then measuring risk is a vital,
complex, expensive and time-consuming pursuit. How many fund-of-funds invested in Madoff after extensive due-diligence and were blindsided by the risks they had taken?

Conversely, with MarketRiders passive strategy using ETFs, risk is simple to measure. In return for giving up the prospect of outperforming the market you lower risk, pay lower fees and statistically, “outperform” most who are paying for performance. In a MarketRiders portfolio you’ll never find hidden leverage, quant algorithms predicting market moves, quirky money managers, conflicts of interest or managers placing large bets with your money.

We measure performance by how efficiently our portfolios deliver returns given the
level of risk you were willing to assume (read our methodology section). You will get near exact returns for the amount of risk you are willing to take. In 2008, our low risk portfolios were up because they contained mostly bonds, and our portfolios with large equity allocations were down. The reverse was true in 2009. As we say, it’s about as exciting as watching paint dry.