What problem is this portfolio trying to solve?

Recent debate about benchmark-driven portfolio construction and the influence of performance tests has prompted an important discussion within our industry. Questions are being asked about whether benchmarks are shaping portfolio design in ways they were never intended to.

I welcome that debate.

Because for me, it raises a question I've been wrestling with for several years. I spent the early part of my career working in performance and risk analytics.

It was an outstanding grounding in investment management. Every day was about understanding outcomes. Active managers were expected to outperform a benchmark. Passive managers were expected to match one, less fees. We measured active return, tracking error, attribution and risk because understanding both performance and risk is fundamental to good investment management.

Working in performance and risk analytics also teaches you something else.

It teaches you to look in the rear-view mirror.

That's not a criticism. It's simply the nature of the discipline. Performance explains what happened. Risk helps us understand the journey that was taken. Governance rightly asks whether decisions were made consistently and within an agreed framework.

Those disciplines are essential. They help us learn from the past and make better decisions tomorrow.

But over time, I came to appreciate that they answer the second question, not the first.

The first question is much simpler.

What is this portfolio trying to achieve?

That realisation didn't arrive overnight. It emerged gradually through conversations with advisers and periodic reviews of our investment range.

Those conversations were rarely about markets.

They were about clients.

One client needed a reliable income in retirement. Another wanted to build wealth over the next twenty years. A third was looking for a diversified portfolio that could sit at the centre of everything else they owned.

Different clients.

Different objectives.

The more I listened, the more I realised we weren't really designing portfolios. We were solving problems.

It led me to a simple conclusion.

Every investment portfolio is really an answer to a question.

If the questions are different, shouldn't the portfolios be different too? Yet our industry often moves quickly to the mechanics.

• Which benchmark should we use?
• How much active risk should we take?
• What level of tracking error is appropriate?
• How should the portfolio be diversified?

These are all important questions.

They're just not the first questions.

The objective should come first.

Everything else follows.

If the objective is to generate sustainable retirement income, the portfolio strategy should be designed to deliver that outcome.

If the objective is long-term capital growth, the strategy will almost certainly look different.

The investment universe, portfolio construction, diversification, risk budget, benchmark and ultimately the way success is measured should all flow from that initial decision.

They’re not the objective.

They're the mechanism.

Too often, we spend our time optimising the feedback instead of being explicit about the objective.

Perhaps that's why the current debate feels so familiar to me.

I sometimes wonder whether we're really debating benchmarks at all. Perhaps we're debating sequence.

Have we become so accustomed to discussing how a portfolio should be measured that we've started the conversation before we've properly defined what the portfolio exists to do?

Benchmarks remain an essential part of investing.

So does performance measurement.

Without them, we can't assess whether a strategy is delivering on its promise. But measurement is feedback.

It tells us whether the mechanism is working.

It shouldn't determine what we're trying to achieve in the first place. I often think of it like driving a car.

The dashboard tells you your speed, fuel level and engine temperature. Your GPS tells you whether you're still on the right route. They're all essential pieces of information.

But none of them tells you where you're trying to go.

The destination comes first.

Everything else helps you get there.

Investing is no different.

The best investment discussions I've been part of don't begin with a benchmark. They begin with a client.

What problem are we trying to solve?

To stay up to date with all the insights from the team at Elston, click here