January 2020
Portfolio Performance
The cumulative 2019 Performance of various accounts managed by Cereli Inc ranged from 19.6% to 45.3% compared to the S&P500 with 27.5% on a price appreciation basis.
One might say that the accounts that returned less than the market metric were short-changed. If we look at the performances in terms of risk attached to the individual portfolios, we come to an entirely different conclusion.
The risk referred to in this case is described as Beta, a term mentioned in past newsletters. To reiterate in summary form, in this case beta is a measure of the sensitivity of a security or portfolio, relative to the movement of a benchmark index. For example the S&P500 which is and index of 500 widely held stocks in the US equity market.
When return is adjusted for risk by applying beta we get what is called Return-to-Beta (RTB). We can now compare individual performances in the accounts against the market performance in a manner that is a comparison of apples-to-apples, so to speak.
Individual account betas ranged from 0.51 to 0.92 influenced in large part by the way the portfolios were created, taking into consideration the risk tolerance of the account holder. Some investors wish to limit their exposure to the equity markets and will therefore have a portfolio created for them that tends to have a lower beta, since the lower the beta the lesser the account will be prone to the vagaries of the market. The opposite would apply to a portfolio designed for an aggressive investor who was prepared to take on more risk in the hopes of greater returns. Such an account would typically have a beta that exceeds 1.0. Note also that the individual securities that make up an account holder's portfolio can cover a wide range values from negative to positive. We will avoid the arcane topic of calculating beta. Let us also acknowledge that the beta of the market is by definition 1.0 since it is a measure of itself.
With this knowledge we can easily determine the RTB metric by dividing each account's return by the respective beta. In this case we find that a portfolio with a return of 45.3% for the year and a beta of 0.92 had a Return-to-Beta of 0.49. And an account with a 19.6% return and a 0.51 beta had a 0.39 RTB. Since the market's return was 27.5% that translates to an RTB of 0.27, which was lower than the lowest RTB of all the accounts reviewed.
The lowest ranked account in terms of cumulative performance for 2019 was lower than the market by almost 800 basis points, yet had a better risk-adjusted return than the market. (One hundred basis points equals one percent).