Practical analysis for investment professionals
11 May 2015

Portfolio Evaluation: Benchmarking for Success

Although portfolio evaluation is the last step in the portfolio management process, it is by no means the least important. On the contrary, proper performance measurement, attribution, and appraisal can enhance the probability of success for the entire investment process. Improper evaluation, on the other hand, can directly create some of the often-criticized issues in the investment industry. (For example, Nobel laureate Myron Scholes believes benchmark and tracking error can derail an investment process. I discussed what this meant with him in detail last week in Tokyo. Stay tuned for my write-up.)

In this fourth installment in the multi-asset strategies series, we discuss three important issues in portfolio evaluation and some institutional investors’ best practices.

1. How should we deal with the conflict between long-term investment goals and short-term evaluation cycles?

Many investment managers follow investment processes that are inherently long term. For example, value strategies often take a full market cycle to bear fruit. If investors hold such managers to a quarterly evaluation cycle, conflicts often arise. Understandably such managers’ returns may end up in the bottom quartile in a quarter. Investors expecting otherwise will be disappointed. Worse, if the managers are forced to modify their process and deliver more consistent returns, they might be become disoriented.

Smart investors have come up with different approaches to deal with this potential conflict.

According to Chiew Kit Tham, managing director at GIC, his firm measures its own performance over a 20-year horizon. He does not think the 65% equities and 35% bond reference portfolio is appropriate for use as a short-term return yard stick but more as a risk measure. He admits that external active managers have a much tighter leash, although private market managers are allowed more time to demonstrate their competence.

The success of the Thai GPF fund is judged by its performance relative to consumer price index (CPI) over 10 years, says Nachcha Protpakorn, deputy secretary general of the Thai Government Pension Fund (GPF). Each year they also measure the portfolio’s performance against a global benchmark reset each year opportunistically.

My Take: Measuring a multi-asset strategy’s long-term performance over inflation and short-term volatility relative to a simple equity plus fixed income reference portfolio seems to help motivate managers to resolve the conflict between long-term goals and short-term evaluation cycles.

2. Should performance evaluation be quantitative or qualitative?

Various formulas come to mind when people talk about performance evaluation. The standard attribution formula is an integral part of the CFA® curriculum. GIC also uses regression analysis over various periods to measure return drivers in their portfolio, such as equity, emerging markets, and credit. The team will then adjust portfolio exposures accordingly where necessary.

Richard Brandweiner, CFA, CIO of First State Super, prefers using the expert panel approach. His team focuses on the economic rationale and systematic exposures (i.e., factors) in their analysis. They look at each manager and debate what the key contributing factors are to the portfolio’s performance. Brandweiner limits the discussion to three exposures in each case so as not to over-engineer the outcome.

For the overall portfolio, Richard crosschecks the return/risk exposure and the probability of achieving these.

My Take: The key to performance evaluation is understanding the return drivers. There is no inherent conflict between the qualitative and quantitative approach. In fact, I believe they are complementary. The quantitative approach can make the assessment more objective, while the qualitative approach might help illuminate the big picture and deliver a sanity check. A good quantitative model requires good intuition while good qualitative analysis can always benefit from the validation that a quantitative assessment of the same portfolio provides.

3. Should performance for active and passive portfolios be measured differently?

Tomas Franzén, chief investment strategist at Second Swedish National Pension Fund – AP2, thinks so. AP2 has developed tilted indices for portfolios they manage in-house using an active quantitative process. They reserve the market-weighted indices for use in evaluating the passive funds.

My Take: Using a tilted index is the natural evolution as our understanding of return drivers improves over time. A value manager will increasingly be asked to outperform the value index and not just the broad market as investors are educated on the impact of value and other factors on portfolio performance.

An important caveat is that we need not lose sight of the long-term goal (total return) of investing when drilling down to drivers of active returns. Total returns are apparently more relevant for asset owners and average investors while understanding active return drivers is of critical importance in manager selection. Only a holistic review provides the full picture.

In summary, portfolio evaluation can be much more than just producing a score card. There are various approaches investors can take in the process to enhance portfolio performance.

This is the fourth article in the multi-asset strategies series. The first three posts were: Multi-Asset Strategies: A Primer,” “Three Key Decisions in Formulating an Asset Allocation Strategy,” and “An Advance in Portfolio Construction.”

For more in-depth coverage of these topics, Multi-Asset Strategies: The Future of Investment Management is available to CFA Institute members.

If you liked this post, don’t forget to subscribe to the Enterprising Investor.

All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Photo credit: ©

About the Author(s)
Larry Cao, CFA

Larry Cao, CFA, senior director of industry research, CFA Institute, conducts original research with a focus on the investment industry trends and investment expertise. His current research interests include multi-asset strategies and FinTech (including AI, big data, and blockchain). He has led the development of such popular publications as FinTech 2017: China, Asia and Beyond, FinTech 2018: The Asia Pacific Edition, Multi-Asset Strategies: The Future of Investment Management and AI Pioneers in Investment management. He is also a frequent speaker at industry conferences on these topics. During his time in Boston pursuing graduate studies at Harvard and as a visiting scholar at MIT, he also co-authored a research paper with Nobel laureate Franco Modigliani that was published in the Journal of Economic Literature by American Economic Association. Larry has more than 20 years of experience in the investment industry. Prior to joining CFA Institute, Larry worked at HSBC as senior manager for the Asia Pacific region. He started his career at the People’s Bank of China as a USD fixed-income portfolio manager. He also worked for US asset managers Munder Capital Management, managing US and international equity portfolios, and Morningstar/Ibbotson Associates, managing multi-asset investment programs for a global financial institution clientele. Larry has been interviewed by a wide range of business media, such as Bloomberg, CNN, the Financial Times, South China Morning Post and the Wall Street Journal.

6 thoughts on “Portfolio Evaluation: Benchmarking for Success”

  1. 吴卓凌 says:


    Thanks for the former 4 articles in asset-allocation series. Excellent insight! I have shared them in my wechat friend circle. Hope more and more professionals in China can read cutting-edge thinkings in asset allocation.

    As we all known, style drift is very common in China asset management in practice. For example, money managers will be regarded as beat the market not only because he outperformed the CSI 300 index in the overall 2014, but also from 2014Q1 to 2014Q3 outperformed the small-cap index and in 2014Q4 outperformed the large-cap index. And actually, many money managers successfully did it.

    My questions is:
    1. How to capture the style drift in the portfolio quantitatively or qualitatively?
    2. Luck may be an explanation for style drifting practitioners. But how to evaluate and compare two style-drifted money managers?

    Thank you!

    Zhuoling Wu

    1. Zhuoling,

      Great question, almost deserving a separate post. Before then, here is my quick response:

      First, many investment professionals, including those referenced here in this article, would want to look at performance issues including style drift over the longer term. So how long is long term? Hard to say exactly but generally longer than a quarter or even a few quarters.

      Second, there’s a tendency to over specify styles – in the second article in this series, one panelist mentioned that they had 39 aset classes at one point. There are tools that would treat asset classes as styles. If we are talking about 39 styles as a result, it is not very meaningful because many of the 39 asset classes are driven by the same factors.

      Once we are sure that we are looking at a reasonable set of factors over a long enough period, then any style shift still present needs to be carefully evaluated against the manager’s stated objectives. Intentional style shift that improves returns is an integral part of dynamic asset allocation programs. For managers who claim they attempt to stay within a style box, then they clearly have not delivered on their promises.

      Thanks again for the question and for your help in promoting our content among your friends.


  2. tyc says:

    I think style drift is the differences between the original investment strategy (predetermined sector weights, risks, positions…etc) versus what is the portfolio holding now. Measuring return, then rebalance / strategy changes need to be included. If these information is available, then Q1 could be answer.

    Luck is very difficult to measure and probably impossible to calculate in the short run. However, luck doesn’t last forever. Thus, I think luck maybe calculable in the long run (using the style drift definition). This leads to another question, what time frame should be consider as short run? Maybe someone else can answer that.

  3. David Botbol says:

    Hi Larry,

    Please allow me to share with you what the sages of the Talmud wrote 2000 years ago in tractate Baba Metzia page 42a

    Here is their advice : When it comes to investment : “Man must divide his assets into 3 pockets: 1/3 Liquidity, 1/3 Land, 1/3 Professional assets” …

    Does it sounds familiar ?

    Let’s look at it from a risk allocation point of view.

    1 -The personal risk bucket, or safety portfolio, is designed to protect the
    investor. This bucket offers the certainty of protection from anxiety. It
    offers below market returns. this is 1/3 Liquidity (in Hebrew : תחת ידו )

    2 – The second bucket, or market risk portfolio, is the most efficient way of
    getting return per unit of market risk. 1/3 market : Yester-year’s Land are today’s financial markets. Indeed, they were the speculative part of a portfolio where consumer staples were produced : cereals, herd…

    3 – The third bucket : 1/3 professional assets is the “Aspirational” Risk portfolio. This bucket offers the possibility for wealth mobility, which can arise from human capital, highly concentrated stock position, stock options, business ownbership.

    As King Salomon wrote : “nothing new under the sun”. The current risk allocation has been present in the mind of people for ages.

    As a conclusion, this 2,000 old piece of advice goes even further than today
    risk allocation strategy : it caters for the 3 basic and fundamental needs of people : the need for security, the need for growth and the need for hope.

    All the Best

    David Botobl, CFA

  4. Sarah Reicks says:

    I apologize that this may not be the best place to ask this particular question but I have a client who is interested and I would like to find a person knowledgeable on the subject.

    Is it possible to calculate accurate performance measurement from doing a screen scrape to a data aggregation service?

  5. Larry Cao, CFA says:


    There is nothing wrong with the screen scraping method itself. The key with accurate performance measurement lies in accurate data (and proper methodology). So in this case you want to be sure that the website is a trusted source and the precise data points as required by the methodology are available.

    Warm regards

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