Understanding Performance in Goal-Based Investing

In a previous article, Whose Performance Is It Anyway?, we explored the significance of performance measurement in goal-based wealth management. The key takeaway was that when assets are managed to meet client-defined outcomes within their individual tolerances, performance is largely a reflection of the choices made by the client rather than the firm.

If firms focus on their own performance as a contest, this can interfere with their true role—helping clients make the best decisions for their financial goals. However, performance measurement remains essential for accountability. In this article, we explore how benchmarks should be used to measure the contribution of both the firm and the client in goal-based investing.

The Role of Benchmarks in Goal-Based Wealth Management

The Financial Conduct Authority (FCA) requires discretionary managers like Fowler Drew to:

• Measure and report client performance at least quarterly.
• Compare performance with an appropriate benchmark.

In our approach, benchmarking is done at the level of the virtual goal-based portfolio, as this is what is being managed to deliver planned outcomes. However, what constitutes an appropriate benchmark is not clearly defined by the FCA—leaving room for firms to use misleading comparisons, often to their advantage.

The FCA also mandates a warning that past performance is not a reliable indicator of future results. While this may be true, benchmarking still plays a crucial role in quantifying divergences in performance and explaining their causes. To do this effectively, we use two different types of benchmarks:

1. A benchmark for the client’s choice of strategy—assessing the impact of choosing a goal-based, liability-driven approach rather than a conventional approach.
2. A benchmark for our tactical decision-making—measuring the effectiveness of our investment implementation against a neutral, rules-based approach.

Benchmarking the Firm’s Tactical Decisions

The performance of every individual spending goal is measured against a customised dynamic benchmark. This benchmark evolves over time, reflecting the glide path for derisking the portfolio by gradually replacing equities with risk-free assets as the plan’s duration shortens.

How the Dynamic Benchmark Works

• Each spending plan has its own risk profile, which determines how and when derisking occurs.
• The glide path assumes markets are always in ‘normal’ conditions, meaning that each asset class delivers returns in line with its historical trend.
• If markets deviate from their long-term trends, we adjust allocations accordingly.

For example, if equities are undervalued relative to their historical trend, we may increase exposure to equities beyond the default glide path. Conversely, if equities are overvalued, we may reduce exposure. The difference in return between our actual decisions and the benchmark’s default allocation tells us whether we have added value through tactical adjustments.

For 100% equity portfolios (which have no glide path), the benchmark is based on our normal portfolio weights, assuming observed trends and risk measures.

By comparing actual returns against these benchmarks, we can answer the question:
“Has Fowler Drew’s tactical decision-making added value compared to a neutral, rules-based strategy?”

Benchmarking the Client’s Decision

Every Fowler Drew client who chooses a goal-based, liability-driven approach could have chosen a more conventional private client service, where portfolios are designed using standard risk-based allocations.

To quantify the impact of choosing our approach, we compare actual performance against the most appropriate industry-standard benchmark, assuming the client had adopted a traditional volatility-driven strategy.

How This Comparison Works

• Conventional wealth management firms typically use risk-based models (e.g., "Cautious", "Balanced", "Adventurous"), which are largely determined by volatility, not outcomes.
• These models allocate a fixed mix of equities and bonds, often without considering the timing or certainty of required cash flows.
• To benchmark our performance, we identify the closest matching risk-based industry index and compare returns over time.

For 100% equity portfolios, we avoid traditional industry benchmarks (which often include hedge funds and property). Instead, we compare against a composite benchmark of 50% FTSE All Share and 50% FTSE All World ex UK.

By comparing performance with this benchmark, we can answer the question:“Has Fowler Drew’s goal-based strategy delivered better or worse results compared to a traditional volatility-driven approach?