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The performance of listed companies is frequently discussed, often in the context of remuneration packages for executives and the performance hurdles required for these to exercise executive options.

The performance over a period such as one year of the share portfolios owned by individual investors is discussed less frequently. One reason for this is the difficulty of measuring investment performance objectively. Another is that such an exercise really produces interesting but quite useless information.

When the results are good the investors concerned congratulate themselves or their advisers. However, they get a misleading impression of their infallibility. In the reverse situation, all that they can do is get out their handkerchiefs and wipe away their tears – although possibly they can learn lessons as to how to do things better in the future.

A further matter to be considered is what yardstick should be used when looking at performance.

One way is to have regard to the absolute performance of the portfolio – effectively the answer to the question: “How much has my net worth increased?” This approach uses the philosophy of “absolute return” managed funds. Individuals and superannuation funds often postulate a target – for example, the consumer price index plus three percentage points. The higher the risks being run the higher the margin in the target rate needs to be.

Another way is to look at the relative performance: “How does my fund’s outcome compare with that of a particular yardstick?” Relative performance is favoured by most managed funds managements, but this yardstick can lead to individuals saying things like: “We congratulate ourselves on having outperformed the All Ordinaries Index by 10 per cent. However, unfortunately our total wealth went down by 15 per cent.”

The yardstick

The above raises the question of just what constitutes a suitable yardstick. For equity and growth portfolios the All Ordinaries Index or the S&P/ASX 200 Index can be used. The former is more suitable for diversified portfolios which include small capital stocks. The latter would be more suitable for portfolios which focus on the leaders.

Alternatively, one can use as a yardstick the performance of a listed investment company – for example, Australian Foundation Investment Company (AFI) or Argo Investments (ARG).

For fixed interest portfolios the returns can be compared with Commonwealth bond yields (which can be downloaded from the RBA website). Using published managed fund returns would be less suitable here, as many of these funds are active traders in fixed interest securities, whereas most individual investors are not.

The performance of these funds would include capital gains and capital losses from trading. Managed funds also involve fees. They would probably publish “after tax” returns, whereas individuals would usually look at their own returns on a “before tax” basis.

Investors with a mixture of equities and fixed interest investments (including cash) should probably look at these two components separately.

Another way to measure performance is to add the dividends received during the year to the end-of-year total market values (say), ignoring taxation and imputation credits. The result can then be benchmarked against an accumulation index.

Arithmetic

Finally, the question arises of how best to do the actual arithmetic when measuring portfolio performance.

The method described requires no particular mathematical knowledge or aptitude, but it assumes a basic familiarity with spreadsheet applications.

The table below illustrates a simple method using an Excel spreadsheet. This approach can readily be used by all investors – they just need to insert their own dates and amounts.

The worked example deals with the performance over one year (the most commonly used period), but the same method can also be employed for periods greater or less than one year.

The Cells

A guessed rate of return has to be put into cell E6. This does not need to be very good guess – an arbitrary figure such as 10 per cent as in the example will do. The program will put its result into this cell when it finishes its calculations (20.22 per cent in this example).

The other cells are filled in as follows:

B13 has the balance date of the previous year and D13 has the total market value as at that date. 

B17 has the balance date of the relevant year and D17 has the total market value as at that date, shown with a minus sign.

Similarly lines 14 and 15 deal with money put in and line 16, using a minus sign, deals with money taken out.

C13 uses the formula =B$17-B13. This formula is then copied into C14 to C17.

E13 uses the formula =D13*(1+E$6/100)^(C13/365). This formula is then copied into E14 to E17. This approach ensures that each item contributing to the return for the year is given its correct exposure on compound interest principles. This is much more accurate than the approximations sometimes used.

E19 uses the formula =SUM(E13:E18).

Money put in includes amounts spent on share purchases together with amounts spent taking up rights issues and exercising options. Money taken out includes not only sales proceeds but also capital returns and the cash part of takeover considerations.

After that Tools – Goal Seek is clicked and the following are entered:

Set Cell $E$19
To Value 0
By Changing Cell $E$6
OK

Magically, the desired return will then appear in E6.

Overseas Investments

Finally, an unrelated aspect not dealt with in Part 1.

A further complication which arises for persons who hold investments in overseas companies should be mentioned for the sake of completeness.

To illustrate:

For benchmarking United States stocks an American index such as the Dow Jones Industrial Average or Standard and Poor’s 500 Index needs to be used, rather than an Australian index.

It is, of course, possible to measure the performance of such a component of a portfolio either in United States dollars or in Australian dollars. The latter brings in gains and losses from movements in the exchange rate and may therefore be more relevant for measuring the wealth of Australian residents.

The same spreadsheet methodology can be used for either currency.