Do You Always Profit By Beating The Market?

July 21, 2014

Do you always profit when you beat the market? Say Fund ABC beat the market by 10%. On a relative basis, it’s positive. But what if the market was down 20%?

You would still be down 10% on an absolute basis!

Absolute Returns Vs Relative Returns

1) Absolute Returns: What you see is what you get; if you get a 10% return you made 10%.

2) Relative Returns: What you get over the benchmark; if you made 10% and the benchmark 5%, you outperformed the benchmark at +5%.

On the other hand if you made 10% with the benchmark up 15%. Tough luck, you underperformed the benchmark at -5%.

Why Relative Returns?

We tend to measure performance against a yardstick, we feel more comfortable where we know where we stand against others.

Easy to understand with just a single number showing if you beat or lagged your peers.

Why Value Investors Like Absolute Returns?

You might like to read up on some characteristics a value investor might have in our previous article 😀

1) Relative returns can’t be eaten:

If you beat the market by 2% but the market is down 10%, you are still down 8%.

2) Different from the crowd:

Being value investors, when we invest we are essentially standing on the opposite fence from the crowd. It could be implied that our investments would not be the ‘in thing of the moment’. Given that we were vested in companies shunned by the market, it may not be appropriate to measure our performance directly against the market. It may not be a 100% apple-to-apple comparison!

When Is Relative Returns Important?

Although benchmarks aren’t a 100% match to most of our portfolio, comparison with an appropriate benchmark over a 3-5 year period would give us an indication if we are competent money managers or should we just buy an index fund and tag along with the market. “If you buy the market, you can’t underperform the market!”.

We can basically view the benchmark as an alternative investment option!

Value In Action

When picking a benchmark, we absolutely have to pick an appropriate one. If one invested in Hong Kong, Malaysia, Singapore, South Korea and Thailand companies, measuring performance solely against the STI ETF (SGX: ES3), Hang Seng Investment Index Funds Series II – HIS ETF (2833:HK) or Lyxor MAL 10US$ (SGX:G1M) wouldn’t be a fair comparison. It would be like “judging a fish by its ability to climb a tree”.

A more relevant benchmark would be the iShares MSCI All Country Asia ex Japan ETF (NASDAQ: AAXJ). To beat the market, we have to know what market are we beating 😀

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All views and opinions articulated in the article were expressed in Mun Hong’s personal capacity and do not in any way represent those of his employer and other related entities. Mun Hong do not own any shares in the companies mentioned above.

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