The Missing Key to Optimal Investment Performance - Part 1
Crosspoint Plaza - Indiana
Every investor knows the feeling. Looking through their investment portfolio, they find a mix of great successes and disappointing failures. Figuring out why some investments didn't perform well is something investors do repeatedly. However, many don't dig deep enough to understand why some managers perform better than others. Often, the key is not in the 'how' but the 'why.'
Beta - What the Market Gives
Let's start with beta, a term related to market returns. For example, in 2015, Manager A bought a prime office building, and Manager B bought a warehouse. The impact of COVID-19 on office property values and the e-commerce boom explain the difference in their returns. Assuming both properties performed average for their types, their returns represent their beta. However, investors in these properties received below-market returns due to managers' fees. Investors naturally seek managers who can provide returns above market beta, known as alpha.
Seeking Alpha – The Holy Grail of Investing
No investor wants a manager who only delivers market beta. Investors spend a lot of time searching for managers who can deliver alpha. Let's explore some common pitfalls that investors should avoid.
Mismatched Benchmarks
Managers often compare their results against benchmarks that make them look good. While this is understandable, it's not very useful for informed investors. A savvy investor ensures that a manager's results are compared against a relevant benchmark.
For instance, let's compare Manager A and Manager B again. Suppose Manager A generates 100 basis points of alpha compared to the office market, while Manager B only delivers beta. Against their specific benchmarks, Manager A clearly provides more alpha. However, if compared to the overall real estate market, Manager B might appear to outperform Manager A.
To determine the correct comparison, we need to understand the investor's intentions. If an investor chooses a manager for their overall real estate allocation with the flexibility to invest in any type of property, the overall market benchmark is appropriate. However, if the investor selects a manager for a specific property type, the manager should be measured against the relevant product type benchmark, and the investor's performance should be measured against the overall market benchmark.
Stay tuned for part 2 where we explore more pitfalls that investors should avoid.
Dan Andrews
CEO