McMurtry Investment Report – September 2024

What Does Investment Performance Mean to Me?

When I was young, I thought that the term investment performance only referred to my absolute return. Going for the home run investment seemed to make the most sense to me at that time.

Now that I am older, I view investment performance as something quite different. A former neighbour of mine informed me that her son was a terrific investor having made a lot of money on bitcoin. Being diplomatic, I decided not to tell her what I actually thought of her son’s investment success.

Her son was clearly lucky, but not a savvy investor. Gambling with one’s capital has never been a strategy I follow.

Total Return vs Percentage Change in Price Return

Many investors only focus on the absolute price return with no regard for the dividend. Unfortunately, most discount brokerage sites only refer to performance as the percentage change in price. This is unfortunate as a good portion of one’s performance lies in the dividend.

Ycharts, the data base I use, provides both types of returns. Total Return is really the only form of investment performance that you should be using.

Use of Leverage in Earning Investment Returns

There are more equity mutual funds and ETF’s today than there are individual stocks. The poor investor is left with so many options to choose from that they are often misled or misinformed by what they are actually investing in.

Equity funds and ETFs that use leverage are much higher risk than the ones that do not. This is true even if the underlying investment is a conservative one. Leverage means they are borrowing to invest in order to try to get higher than benchmark index returns. Leverage only looks good when the equity markets are rising. In a bear market funds that use leverage sharply underperform the benchmark indices often leading to negative returns.

Active vs Passive Investments

Whether you only use ETFs or individual stocks, there are two very different types of investment styles. Active managers use tactical asset allocation to try and beat the index benchmark returns, while passive managers are only trying to emulate the benchmark indices.

Absolute Return vs. Risk Adjusted Rate of Return

The absolute return may or may not use dividends plus price appreciation. However, the risk adjusted rate of return is used frequently amongst seasoned money managers to determine how a stock or equity sector will perform based on the underlying risk.

In this case risk is measured using the investment term beta. The beta of a stock is how much it moves up or down relative to the risk taken on. A stock with a beta of 1 normally goes up and down by the same percentage as the overall index being measured. A stock with a beta of 1.5 times means that the stock will go up by 50% more than the index but will also fall by 50% more than the index return.

Let’s say a stock has a beta of 1.7 times the market. If the market goes up by 20%, then the stock in theory should go up by 1.7 times the market or 34%. If the stock’s actual price movement is by a percentage increase of 25%, the stock has a risk adjusted rate of return of minus 9%. This is the case even though the stock performed better than the market.

The whole point of diversification is to minimize the volatility of the portfolio. Portfolios that are only built using high risk will eventually have negative returns that are excessive.

One older seasoned portfolio manager told me many years ago that the worth of a good manager is not seen when the market goes up, but is seen in a bear market. Risk minimization strategies are used by the experienced manager to reduce the price fluctuations. This can be accomplished by raising some cash, rotating into less volatile stocks and equity sectors during a bear market.

Conclusion and Recommendation

Achieving good investment performance over the long term can be best accomplished by the following:

Do not ever use leverage to invest

Be pro active, not passive with your investments.

Always know the amount of risk you are taking in regards to the asset mix, equity sector weights and the type of individual stocks you own.

Try to familiarize yourself with Risk Adjusted Rates of Return. If you are taking too much risk, make a conscious decision to reduce the risk.

Always Use Total Return to measure your overall performance, rather than the percentage price change only.

By properly diversifying by asset class, by equity sector, by credit quality and average term in the fixed income area and lastly by limiting the percentage weight of each individual stock will improve the consistency of your returns.

Once you start focusing your investments based on the amount of risk you take, you will start to feel a lot more comfortable.