Performance Analysis of Managed Portfolios with Contributions and Withdrawals

The performance of your portfolio depends on what your alternatives are and their management expenses, return, and risk. Benchmark portfolios are market alternatives to managed portfolios that are good substitutes for a managed portfolio. If a benchmark has lower expenses and better risk and return properties, you should consider switching. However, the preferred portfolio depends on the proper analysis of their comparative performance.

The Problem

Out of pocket cash transfers or security transfers from one portfolio to another are a common occurrence in managed portfolios but not benchmark portfolios. The problem is that these contributions and withdrawals seriously affect the calculation of a managed portfolio’s performance. The same transfer amount and timing must be applied to benchmarks to obtain a comparable performance analysis.

Types of Portfolio Transfers

Transfers are defined as Contributions or Withdrawals external to or from the managed portfolio. The transfers can be in the form of cash or securities originating directly from or to the owner or an external portfolio. This could also include cash contributed or withdrawn to pay Management Fees, if those fees are not paid directly from the portfolio's cash account.

Transactions within the portfolio, such as

• changes in the asset allocations, including cash, in the managed portfolio,

• interest/dividends/splits/spinoffs,

• brokerage fees, and

• asset purchases and sales

• are not Transfers.

A Misleading Practice

A common investment management practice is to simply show a plot of the benchmark’s growth in value from some standardized starting value, such as $100,000, over the analysis period. Whether this is informative to a portfolio’s owner, depends on the portfolio’s transfers. Typically, only the portfolio’s monthly values, after transfers, are included in the chart versus the benchmark’s monthly values, excluding those transfers. Unfortunately, the benchmark is not typically adjusted for the portfolio’s transfers. Depending on the size and timing of the transfers, the effect on comparative analysis period values can be large and the relative performance incorrectly measured.

An Example

To illustrate the problems with omitting the portfolio’s transfers in the benchmark, we show the RoboPPA™ results from a December 31, 2019, $100,000 investment in the market index ETF, with a $20,000 portfolio contribution made post crash on March 31, 2020 and also invested in the market index. In this simple example, the logical benchmark is the market equity index ETF; however, the index was not adjusted for the portfolio's transfers. A

RoboPPA™ chart of the portfolio and unadjusted benchmark is shown below.

RoboPPA™ calculates the Aug. 31, 2020 portfolio ending value, after transfers, of $123,958. The ending value of the unadjusted benchmark is $97,116, a substantially smaller value, representing a -27% error relative to the starting portfolio value. If a $20,000 contribution was added to the benchmark on March 31, 2020, the benchmark ending value should also be $123,958, as correctly calculated by RoboPPA™.

Conclusion

It is imperative that benchmark portfolios are adjusted for the transfers that occur in a managed portfolio. Failure to do so, may result in a large error in performance. In this example, the dollar value-added by the portfolio, relative to the benchmark, is vastly overstated because of the benchmark’s $20,000 omission of the contribution and its timing. On the other hand, if the transfer had been a withdrawal post March crash, an error favoring the benchmark would have occurred.

A significant advantage of RoboPPA™ is that the required inputs for its performance analysis can be saved in its template and updated monthly. This can be done entirely on the user’s computer and never stored on the software’s servers. The software maintains the benchmark databases thereby reducing the user’s work. Finally, the software allows analyses over any selected period contained in the data template's horizon, providing it exceeds nine months.

Caveats

The analysis and the results in this document are not to be interpreted as representative of real markets and asset classes and are not warranteed to be correct or complete. The example is based upon our opinion and interpretation of the data and results, which may be incomplete or incorrect. RoboPPA™ or the data suppliers are not responsible for any damages or losses arising from use of this blog. Details on the performance calculations are available in www.RoboPPA.com.