For our more experienced investors, how would you like to looking into some more sophisticated measurement methods? Last month, one of my favorite websites – Investopedia – published an article by Gary Barohn, entitled, “Does Your Investment Manager Measure up?
This is a popular evergreen topic for investing columns. We’ll lightly discuss some of Barohn’s suggestions, since his article is light-hearted, too.
He leads by suggesting that you are at a “fancy party,” where financial professionals are discussing performance metrics, but you hardly understand a word. So, he helpfully gives brief definitions of terms and links to more in-depth discussions.
For example, what do you suppose “Alpha” is? It is a way of measuring “investment performance adjusted for the risk taken,” i.e., amount of return that beats the market.
How about “Beta?” This compares volatility of the manager’s investments compared to the volatility of the overall market. “Volatility” measures how far dips fall and peaks rise.
Other metrics are R-Squared, Standard Deviation, Tracking Error, etc.
IFO remembers the term Standard Deviation from her college statistics class, though she has forgotten how to find it. The SD shows how far away a curve is from a straight line drawn through the center of it. VERY difficult concept and calculation for IFO.
One of her biggest problems with these metrics is the use of the term “risk.” We think it actually means yield or rate of return (yield plus price increase/decrease) or just plain old interest on investment.
But investment managers throw the term around like a Ping-Pong ball. Investors are urged to learn what their “risk tolerance” is. We’ve taken those tests and find them curious – kind of a moving or morphing measurement, with no firm meaning.
The other problem is that it is just too hard to do the math AND understand exactly what it means.
We leave it to our more mathematically-inclined readers to parse the article. It may actually be helpful. We, on the other hand, will stick to looking at each company’s dividend policy and CEO personality for our primary metrics. Easier and more fun and perhaps as successful as the Big Math proponents.
And now for something completely different: Normally, IFO loves the picture window which has a view of the street running by her office – but just now she saw a very tan, very fat older man, wearing ONLY black shorts, slowly pedaling his bicycle down the street. Help! Eyes! Bleach!]
What do we learn from this? Even major benefits carry serious downside risks.