Bad Comparisons Can Lead To Faulty Conclusions - Weekly Blog # 905

Mike Lipper’s Monday Morning Musings

 

Bad Comparisons Can Lead

To Faulty Conclusions

 

Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018

 

 

 

Your Portfolio vs. Stock Indices

The biggest trap the media and sales community set for both institutions and individual investors is comparing portfolio performance with a stock index constructed by a publisher. The best US stock market index is probably the S&P 500 Composite (SWX is its symbol).

 

The index is published by Standard & Poor’s Global (*), whose components are selected by data analyst editors, not investment managers. In a performance year where a company splits into two or more publicly traded stocks; the index carries each component of the former stock for the performance year. That is why the SWX measures slightly more than 500 stocks at times. Additionally, almost every active investor’s portfolio contains some cash or similar instrument. In periods of large gains or losses, the performance of non-equities will affect the performance of an account, but not the index. Furthermore, it is extremely rare for an active portfolio to own anywhere close to 500 names.

(*) Owned in client and personal accounts

 

In measuring the performance of the SWX, the measurement compares the closing trade price of the prior trade date to the ending price of the current day. It is extremely common for the ending price to be higher or lower than what an investor receives, so the actual performance of an active account is likely to be different than an end price calculation.

 

The management committee of the Wall Street Journal and the Standard & Poor’s editors have decided that SWX will only contain stocks that are listed on US stock exchanges. They also do not limit the percentage size of holdings in the composite, while the SEC limits diversified mutual funds to holding no more than 5% weighting within the portfolio of any given stock at cost (not market). Non-diversified funds are not restricted this way.

 

In today’s world, managed accounts are almost certain to hold cash or fixed income instruments as redemption reserves. Additionally, opportunity reserves will in many cases include non-US listed securities.

 

Many years ago, for these reasons, we convinced a number of outside directors of mutual funds to compare the performance of their funds to similar portfolios of funds. I believe this is the way almost all investment accounts should be measured, whether they are funds or not.

 

Other Mis-labeling

Last week, three of the five leading large-cap stocks were labeled financials; JP Morgan Chase (*), Morgan Stanley(*), and American Express(*). None of the articles I read mentioned that Charles Schwab(*) was the fourth largest declining large stock on Friday. Clearly, Schwab has something else going on that the first three do not, despite sharing the same industry label.

(*) Client or personally owned

 

Also last week, there was no mention of various countries whose local market indices showed gains, Europe 6 and Asia 12.

 

Another example of incomplete labeling was a headline of Goldman predicting that “Gold will hit close to $5000, if Trump undermines the Fed”. Perhaps true, but other commodities and some foreign stocks may do just as well. (Coincidently, a strategic collaboration between Goldman and T. Rowe Price to create a range of public and private investments was also announced. As a part of this collaboration, Goldman will invest $1 billion in open market purchases of T. Rowe Price stock.  Perhaps the more important message, is that Goldman believes the market is not offing enough diversity.)

 

Question: What are your thoughts? 

 

 

 

Did you miss my blog last week? Click here to read.

Mike Lipper's Blog: What We Should Have Been Watching? - Weekly Blog # 903

Mike Lipper's Blog: The Week That Wasn't - Weekly Blog # 902

Mike Lipper's Blog: DIFFERENT IMPLICATIONS: DATA VS. TEXT - Weekly Blog # 901

 

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