How to Evaluate Investment Managers: A Guide to Making Informed Choices

When choosing an investment manager, many investors rely on personal connections. Someone they know, like, or trust. Often, these managers are passed down through generations of family, creating a sense of familiarity. While this desire for comfort is understandable, it can lead to a lack of objective evaluation. Potentially, risking your financial future.

Some investors also work with multiple portfolio managers without a structured process to compare performance. So, understanding how to evaluate investment managers using clear, objective criteria is critical. Especially when your financial security is on the line.

Key Financial Metrics for Evaluating Investment Managers

When evaluating an investment manager’s performance, it’s important to assess specific financial metrics. Avoid simply “going with your gut”. Here are six essential metrics to focus on:

• Period Return: Measures the return generated by an investment or portfolio over a specific period. Reflecting how much value has been gained or lost during that time.
• Benchmark Return: measures the return generated by a comparable benchmark index over the same period as your investments. Reflecting what can be achieved by investing passively in low cost averages.
• Active Return: The difference between an investment’s return and that of a benchmark. A positive active return means the investment outperformed the benchmark, while a negative one indicates under performance.
• Standard Deviation: This measures the volatility of returns. A higher standard deviation means greater risk, as returns fluctuate more significantly from the average.
• Beta: Beta indicates an investment’s sensitivity to market movements. A beta of 1 moves in line with the market benchmark; a beta above 1 is more volatile, while a beta below 1 is less so.
• Sharpe Ratio: A risk-adjusted return metric that shows how much excess return (beyond a risk-free rate) an investment generates for each unit of risk taken.
• Information Ratio: Similar to the Sharpe ratio, but with a focus on comparing an investment’s risk-adjusted return relative to a benchmark. A higher information ratio indicates better performance versus the benchmark.

How to Benchmark Portfolio Performance

Benchmarking is essential when evaluating investment managers and their performance. It provides a reference point to determine whether your portfolio is performing well compared to market standards. For many investors, passive investments such as ETFs and index funds offer compelling alternatives to active management. These strategies tend to have lower fees and can outperform actively managed portfolios over the long term.

While active managers aim to beat benchmarks, passive strategies focus on replicating them. Often delivering more consistent returns with lower costs. Investors should compare the returns of their investments vs relative benchmark indexes. For example, if your Canadian stock portfolio returns 5% this year, but the S&P/TSX 60 Index ETF returns 6%. Then, you’d be better off simply following the index instead of paying for active management. Investors should make this determination to understand if paying for investment advice is worth it.

Understanding the Impact of Fees on Your Returns

Fees play a crucial role in your long-term returns. Even seemingly small fees can have a significant impact over time due to the power of compounding. For example, a 1% annual fee may appear minor in the short term, but it reduces the amount of money you have invested, leading to lower compounded returns year after year.

By lowering a manager’s fee to 0.75% and including the 0.05% fee for our reporting and evaluation services, investors are well below the typical 1% management fee. These savings from reduced fees will greatly boost your net returns over time.

Our Approach: Empowering You to Make Independent Decisions

At Markdale, we don’t provide direct investment advice. Instead, we specialize in writing tailored investment policies that give you a clear road map for decision-making. Then, our consolidated performance reports evaluate your portfolio objectively, using the same criteria discussed in this post.

This approach gives you flexibility, autonomy, and cost savings. Our 0.05% fee is a small fraction of what traditional investment managers charge. While the benefits of better performance magnify over time.

Here’s an example of how we provide comprehensive reporting on the performance of your investment managers.

Ready to Optimize Your Investments? Contact Us

If you’re ready to take control of your investment evaluations and improve your financial future, get in touch with us today. You can book a consultation or fill out our contact form!