“real” versus “relative” return: does this really relate to you?

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“real” versus “relative” return: does this really relate to you?

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Investment managers will frequently report their performance to you by comparing their returns to a benchmark or set of benchmarks. For example, U.S. equity manager returns are often compared to the S&P 500 Index. By so doing the manager is giving you a measurement of relative return which tells you how he/she did—as compared to a specific measuring stick. For example, if the manager reports an annual return of 12 percent and the S&P 500 Index reports a return of 10 percent, one might reasonably conclude that the manager generated a relative return of 2 percent above the benchmark, which of course would be commendable. However, what if the manager’s return was a negative 18 percent and the S&P 500 Index was negative 20 percent? The manager still produced a relative return that was 2 percent better than his benchmark, but in real dollar terms, you lost 18 percent. In other words, your real return was negative 18 percent. Should we commend the manager?

 

Perhaps, since he or she did beat the benchmark. Nevertheless, you experienced a significant reduction in account value. So we ask the question: If my account is losing value, am I happy that I beat the benchmark? When markets are rising, investors tend to focus on relative returns. In falling markets, however, real returns are much more critical. Psychology tells us that human beings are affected much more by loss then gain. In uncertain times such as these, we believe that investment management should focus on opportunities to produce real (positive) returns rather than relative returns.

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