Help Your Clients Look Beyond the S&P

As the owner of a Ford F-150, I don't compare my ride's zero-to-60 performance to a Ferrari or my gas mileage to a Toyota Prius. Each vehicle was designed with a different objective in mind and comes with its own set of expectations. Yet many investors commit this kind of mistake when benchmarking their portfolios, and that can present a challenge for advisors.

Last month's volatility notwithstanding, U.S. stocks have been one of the few shining beacons of positive returns in the global financial markets this year. Most asset classes are in the red, and even in the U.S. the gains are not as widely distributed as they appear. Through the end of October, the 10 largest companies in the S&P 500 accounted for 85% of the index's year-to-date return, and the largest decile represented 110%, meaning the other 450 companies were down on average.

It's understandable that the S&P would attract the majority of the financial media's attention and coverage. It counts among its constituents some of the largest and most competitively dominant corporations in the world, and the index represents just over 80% of the total U.S. public equity market capitalization. But the disproportionate amount of airtime given to covering the biggest 100 or so mega-cap names creates skewed perceptions by individual investors about the state of financial markets and the type of returns "everyone else" is getting.

By the time your client calls you, their advisor, to ask, "Why is my portfolio down when the market is up 5%?" there's a good chance they've accumulated a whole set of unrealistic expectations that are framing the question. This can either be an awkward moment or an opportunity for you to demonstrate your value by educating your clients on the difference between "the market," a particular index, and a diversified portfolio.

Indexes Outnumber Stocks

These days, you can find an index tracking almost anything — emerging markets, tech companies, volatility, growth stocks, value stocks, smart beta, international markets, commodities, industries, and ESG factors, just to name a few. Yet if you talk to most investors, the only benchmark they know is the S&P 500, or for the truly old school, the Dow Jones industrial average.

There are now more indexes tracking stock market performance than there are individual stocks. Advances in technology, the rise of factor investing, and the proliferation of ETFs have driven the number of indexes up at a parabolic rate. Bloomberg reported last year that the number of market indexes quadrupled to 1,000 between 2010 and 2012 and had already crossed 5,000 by the end of 2016, while the number of publicly traded U.S. stocks has fallen to fewer than 4,000.

Resetting Expectations

With virtually unlimited options for benchmarking, it's time to shift our own thinking and our clients' thinking beyond measuring everything relative to the S&P, which in our view has never been the best or most appropriate benchmark for most investors' portfolios. A client who is heavily weighted toward value stocks shouldn't be benchmarking against an index largely composed of growth stocks. A client who is retired and has half their portfolio in bonds shouldn't be measuring their returns against any pure equity index.

It's up to you, the advisor, to reset your clients' default expectation that they should be keeping up with "the market" as they perceive it on CNBC. Most people don't have the temperament and the discipline to ride the ups and downs of an all-stock portfolio, which is one reason few advisors would direct their clients to put all their assets into an S&P 500 index fund or ETF.

Remember, just as there's no ideal portfolio that will work for every client, there's no ideal benchmark for every portfolio. Each must be determined on a case-by-case basis, which often means starting with the end in mind. What are the client's goals? What's their risk tolerance? What are their future liabilities? Having the answers to those questions makes it possible to determine how much risk they should be taking and what kind of returns they need.

Many advisors are already moving away from the traditional S&P or 60/40 benchmarking approach and using goals-based or inflation-based measures instead. It's easier to keep a client committed to a prudent long-term strategy if they can see that they're still on track to achieve their goals and are growing their purchasing power after a market hiccup like the one we saw last month. The key is to be consistent and fight the temptation to move the goalposts by measuring against traditional benchmarks (or playing along when your client does) when your performance looks favorable and switching to alternative benchmarks when it doesn't.

Whether it's a mix of asset classes that roughly matches the portfolio allocation, a lump sum target amount they're working toward, or a measure of purchasing power over time, there should be clear dialogue up front about the choice of benchmark, the rationale behind it, and what successful performance will look like. With consistent reinforcement, it is possible to break free from the tyranny of letting Standard & Poor's dictate whether your performance is satisfactory or not. When it comes to discussions about performance, make sure you're comparing apples to apples and pickups to pickups.

Mark is a co-founder of Intrepid Capital. He is also the lead portfolio manager of the Intrepid Capital Fund, the Intrepid Disciplined Value Fund, the separately managed Intrepid Balanced and Intrepid Disciplined Value portfolios and the Intrepid Capital, L.P. He has over 30 years of experience in asset management. Mark received his B.A. in economics from the University of Georgia. Travis serves on the Board of Trustees of The Bolles School and the Board of Directors of Jacksonville Clay Target Sports. He is also a member of the Ponte Vedra Rotary Club and YPO-WPO.