Why was my portfolio rate of return
less than that of the S&P 500 over the same period?
There will be times when your portfolio outperforms the S&P 500 index, and times when it underperforms. Remember, the S&P 500 index has a very narrow focus of only 500 stocks – all of which are part of one asset class (large market capitalization companies), and all are from only one country (US). MAMC’s equity portfolios, on the other hand, have a much more diversified reach of between 12,000 and 14,000 stocks in 10 to 16 different asset classes, from some 44 different countries.
Additionally, the way the S&P 500 index is “weighted”, makes this index actually more narrow than the 500 stocks that comprise it. It is not an “equal weighted” index – with each of the 500 companies contributing 1/500th of the return of the index. Rather, it is a “market capitalization weighted” index – where the largest companies carry the most weight. So it’s possible to have a year in which more than 400 of the companies in the index lose value, but the index still increases for the year. At last check, the top 10 companies of the S&P 500 carried more than 20% of the weight of the entire index. Below are a couple excerpts from a recent article that underscored the outsized impact that the top company in the S&P 500 (Apple) has on its index:
“In fact, thanks to the fact that the S&P is market cap-weighted, gadget giant Apple now accounts for a 4% of the entire Standard & Poor’s index. If Apple stock was on the decline, it could theoretically cause “the market” to decline — at least as measured by this index of 500 stocks.
In short, one company has enough pull to skew the average in this benchmark that contains 500 constituent companies.”
Here’s another crazy factoid: The 4% weighting for Apple is more than all materials, telecom or utilities stock in the S&P 500 — to make it the eighth-largest “sector” in the entire index. Materials companies make up roughly $446 billion as of Feb. 24, or 3.6% of the index. Utilities were $426 billion (3.5%), and telecom was just $335 billion (2.8%).
So if the utility sector crashed or telecoms soared, it wouldn’t even show up in the S&P 500 if Apple alone moved the other way. “
As you can see, to compare the S&P 500 index to your diversified, global portfolio, is really an ‘apples’ to oranges omparison. Granted, the S&P 500 is a broader index than the Dow 30, but it still only really measures the movement of large, US –based stocks. That’s why we include several other index returns on your performance report for comparison purposes (e.g., Russell 1000 Value Index for large cap value asset class comparison; Russell 2000 Index for small cap asset class comparison; MSCI EAFE Index for international asset class comparison; Barclays Capital 1-3 Year Government Index for fixed income asset class comparison).
In addition to the exposure to more asset classes, all of our portfolios are “tilted” with an overweighting to value stocks over growth stocks and an overweighting of small stocks over large stocks. The reason for this is that, historically, value and small stocks outperform growth and large stocks. Those “tilts” alone will account for some of the differences you might see between your portfolio and certain indices.
Included is a relevant chart that you might find interesting. It’s a snapshot of annual performance of major equity and fixed income asset classes in the world over a 15-year period: from 1997 to 2011. The top portion of the chart ranks the annual returns (from highest to lowest) using the colors that correspond to the asset classes. The bottom portion of the chart displays annual performance by asset class. You’ll notice that in both US and non-US markets, there is little predictability in asset class performance from one year to the next. Studying the annual data in the slide reveals no obvious pattern in returns that can be exploited for excess profits, thus strengthening the case for the method of asset allocation that we embrace – broad diversification
across many asset classes.
We’ve spent a considerable amount of time constructing what we believe to be a very well-balanced, and diversified global portfolios. For a number of our clients last year, their portfolios lagged slightly behind the S&P 500 index. But given the excellent
performance of some of the larger components of that index, as well as the poor performance of international markets where we have some exposure (think about all of the issues in Europe over the past year), the results are not surprising to us at all. The portfolios are doing exactly what they were designed to do.
One of the most important things you can do when tracking your investments is to set the right expectations. That’s why it’s important to judge an investment in the context of your portfolio strategy as well as against the appropriate standard or benchmark.