On Determining Investment Performance

It might be tough defining what a good investment is or what profit means, first because it might be hard to keep track of elements of time, currency, and costs and also because it depends on how the rest of the market has been performing

The reason for investing in the first place is to yield benefits. It doesn’t matter the size or the period the investment was made; the primary reason for it is the resulting gain on the investment.

Investment performance is simply the return that you derive on an investment portfolio and this is typically measured over a specific period of time, on specific assets (or on an asset) in an investment portfolio, and in a specific currency.

While we all know that we want to profit from our investment, determining what ‘profit’ means is relative. For some, profit refers to the high dividends that are received periodically while for others, profit is the ultimate increase in value of the investment.

This is what we refer to as the dividend versus the growth investment return objective. Dividend returns take income in terms of interests and dividends into consideration while growth is determined by capital appreciation alone. However, it doesn’t just stop there.

We established that we can overinvest on an asset making the return less than the cost element, and this too needs to be taken into consideration while determining the profit on an investment. In other words, return or profit needs to either be classified as net or gross return.

While gross return would show all the gains received on an investment, net return is what shows if any of those gains still remain after deducting the costs like expenses, fees, and taxes made on the investment. Neither is a wrong measure of investment performance as it depends on what the investor is trying to measure.

An investor could ‘write off’ the costs involved on a transaction as they needed to be made or because they are essentially out of his control, choosing to focus on the value of the investment alone. While another might take the extra effort to determine the exact gains he got.

A challenge here might also be time. Where an investment is held for a long period of time, say 10 years, the costs expended, income received, and so on, might be hard to determine. Even when they can be determined, the time value of money which is often changing as a result of inflation or the value of our foreign exchange (much like in Nigeria) might make it impossible to accurately compare the costs and profit elements of an investment.

In fact, the currency or constantly changing FX element might make an investment in Naira seem like it had made a loss when compared to an exact investment that had been made in Dollars because of the change in the value of a currency.

Finally, there is also the dichotomy of a time-weighted return and a money-weighted one. This depends on whether the investor or fund manager is timing the inflows and outflows of the investments in the portfolio or whether he is she is just letting it run on its own.

What all of these mean is that essentially, it might be tough defining what a good investment is or what profit means, first because it might be hard to keep track of elements of time, currency, and costs and also because it depends on how the rest of the market has been performing.

This is what brings us to the two ways return is viewed. An investment return is either Absolute or Relative. Absolute is basically what an asset or portfolio returned over a certain period (Like N100,000 gain over 3 years) while Relative return, on the other hand, considers the performance of the market on similar investments which is gauged by a benchmark. (N100,000 gain in 3 years might be a loss when compared to costs expended, inflation, and so on.)

In our next few posts, we would break down Absolute return and Relative return.

Written by Lawretta Egba.