A long time ago, we figured out if you want to earn the trust of someone, you need to look them in the eye, and be open and honest, which is why one of our core tenets at P&A is transparency. Our fee schedule fits neatly on one page and we’re quick to explain how and why we behave the way we do. We want to be an open book for our clients and not hide behind some 100-page disclosure document. Being a fiduciary is in our DNA.
From time to time we get questions from clients about the benchmark we’re using for their account. Most of you reading this are intimately familiar with the S&P 500 or the Dow Jones Industrial Average. Both are U.S. large cap indices that can be used as benchmarks if your stock portfolio consists only of U.S. large cap companies. And for the first 10 years or so of P&A’s existence, we compared our clients’ equity portfolios to the S&P, the Dow, or a combination of both.
But our client accounts are more diversified than just U.S. large cap. We include exposure to midcap, small cap, international, and alternatives as well. During the mid-2000s many of our equity accounts were outperforming the S&P 500 by a decent amount. The reason was international stocks were trumping U.S. stocks, and mid and small cap were outperforming large. We felt it disingenuous to compare only to a U.S. large cap index when we were using these other asset classes as well. So we created the P&A Blend Index to address this concern 10 years ago. This is a blended index that currently consists of the following components:
- 40% in the S&P 500 Index
- 25% in the Dow Jones Industrial Average
- 10% in the S&P 400 Midcap Index
- 10% in the Russell 2000 Small Cap Index
- 10% in the MSCI EAFE International Index
- 5% in the MSCI Emerging Markets Index
We want to know how we’re doing, and while our client accounts typically aren’t invested with these exact weights, a blended index like this more closely resembles how we manage client money. So for any of you wondering why we don’t compare your account’s performance to the S&P 500, it’s because we own more asset classes than simply U.S. large cap.
Those of you with balanced accounts (you own both stocks and bonds) may see a benchmark with a number like 75/25 or 60/40 in the title. This represents the split between stocks and bonds in your account, what we refer to as the asset allocation. What we’ve written about above covers the stock portion. We should also note the fixed income or bond portion of the benchmark is represented by the Bank or America/Merrill Lynch U.S. Corporate & Government 1-5 Year Bond Index.
Some client accounts are invested more conservatively than their benchmark. These accounts tend to underperform in up markets but should hold up better in down markets. Accounts that are managed more aggressively than their benchmark will hopefully outperform in up markets but may underperform in down markets. A clients’ risk tolerance and risk capacity help to determine how their account is invested. The bottom line is that benchmarks are hard to beat. They don’t pay management fees or transaction charges, they don’t have inflows and outflows, and most importantly, they aren’t susceptible to emotions.
