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Indices vs. Portfolios

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  • 1. Indices vs. Portfolios 11988 El Camino Real ❘ Suite 500 ❘ P.O. Box 919048 ❘ San Diego, CA 92191-9048 ❘ 858.755.0239 ❘ 800.237.7119 ❘ Fax 858.755.0916 ❘ info@brandes.com ❘ www.brandes.com At Brandes Investment Partners®, we often field questions about why our portfolios differ from their benchmark indices. For example, we may be asked why the country or industry weightings of a given portfolio are not in line with those of its index, or why the portfolio’s performance diverges from the index’s returns. In this handout, we examine some key sources of differences between our portfolios and their benchmark indices. COMPOSITION ■ index: all or almost all of the stocks in the market ■ portfolio: between 35 and 85 stocks, each trading at a discount to its intrinsic value Many indices, like the S&P 500 or the MSCI World, consist of a large sample of the stocks in the market the indices are designed to represent. Other indices, such as the Russell 1000 or the Dow Jones Wilshire 5000, include literally every stock in the market they’re focused on. In contrast, our portfolios consist of 35 to 85 stocks, each selected because it is trading at a discount to our esti- mate of its fair value. Unlike their benchmarks, our portfolios hold only a fraction of the issues in a given market. This means our portfolios only contain stocks that were trading at prices that we considered attractive at the time of purchase. WEIGHTINGS FOR INDIVIDUAL STOCKS ■ index: based on the stock’s market capitalization ■ portfolio: generally between 1% and 4%, with a maximum of 5% (at the time of purchase) For most stock market indices, an individual stock’s weight is based on its market value (also known as “market capi- talization”), which is equal to its share price multiplied by the number of shares it has outstanding. For example, if ABC Inc. is trading at $50 per share, with 1 million shares outstanding, its market value is $50 million. ABC’s weight in an index would be equal to $50 million divided by the total market value of every company in the index. For our portfolios, we allocate stocks without regard to relative weight in the overall market. Instead, our invest- ment committees focus on the stock’s relative appeal, its fit in the portfolio, and its liquidity. The weighting for an individual stock in our portfolios generally ranges from 1% to 4% – with a maximum of 5% (at the time of purchase.) WEIGHTINGS FOR COUNTRIES OR INDUSTRIES ■ index: equal to virtually 100% of each country or industry’s weight in the market ■ portfolio: free to range from 0% to 150% of each country or industry’s weight in the market, depending on appeal of select stocks within the country or industry Because indices tend to consist of all or virtually all of the stocks in a market, index weightings for countries and industries generally are equal to or very close to 100% of each country or industry’s weighting in the market. For example, if Japan’s market value represents 30% of the value of the entire market, the weighting for Japan in the market’s index also will be very close to 30%. For our portfolios, weightings for countries and industries are driven by our company-by-company search for attrac- tive investment opportunities, not by each country or industry’s weight in the index – though these index weightings
  • 2. Indices vs. Portfolios do help us determine our portfolios’ maximum weightings for a particular country or industry. Specifically, our portfolios’ country and industry weightings may range from 0% to the greater of (a) 20% of the portfolio or (b) 150% of each country or industry’s weighting in the index. (All limits are based on the price of the portfolio’s holdings at the time of purchase). We believe this allows our investment committees to fill our portfolios with the most attractively priced stocks they can find, with flexibility in terms of the stocks’ countries or industries. To illustrate this flexibility, let’s build on the example above, where the index’s weighting for Japan is 30%. If our investment committees have not found any opportunities in Japan, a portfolio might not include any Japanese companies, resulting in a weighting of 0%. Conversely, if the committees have identified several attractively priced companies in Japan, we could add shares of these companies until the portfolio’s weighting for Japan reaches 45%, which would be 150% of the country’s weighting in the index. OVERALL GOAL ■ benchmark: representing the market ■ portfolio: seek to outperform the market The typical benchmark is designed to represent the performance of a particular market. In contrast, our portfolios seek to outperform the markets they’re focused on. With this in mind, we don’t believe that the performance of our portfolios should mirror the performance of their benchmarks as closely as possible. To the contrary, we think our portfolios must perform differently in order to potentially deliver significant outperformance. We understand that this means our portfolios often look very different from the index. However, we believe our willingness to look different – and even to underperform in the short term – is what gives us the opportunity to outperform in the long run. S&P 500: The S&P 500 Index is an unmanaged, market capitalization weighted index that measures the equity performance of 500 leading companies in leading industries of the U.S. economy. Although the index focuses on the large cap segment of the market, with approximately 75% coverage of U.S. equities, it can also be a suitable proxy for the total market. This index includes dividends and distributions, but does not reflect fees, brokerage commissions, withholding taxes, or other expenses of investing. MSCI World: The MSCI World Index is an unmanaged, free float-adjusted market capitalization weighted index that is designed to measure equity market performance of the developed markets throughout the world, including the United States. This index includes dividends and distributions net of withholding taxes, but does not reflect fees, brokerage commissions, or other expenses of investing. Russell 1000: The Russell 1000 Index is an unmanaged, market capitalization weighted index that measures the performance of the large- cap segment of the U.S. equity universe. It is a subset of the Russell 3000 Index and includes approximately 1,000 of the largest securities based on a combination of their market capitalization and current index membership. The Russell 1000 represents approximately 92% of the U.S. market. This index includes the reinvestment of dividends and income, but does not reflect fees, brokerage commissions, withholding taxes, or other expenses of investing. Dow Jones Wilshire 5000: The Dow Jones Wilshire 5000 Total Market Index is an unmanaged, market capitalization-weighted index that measures the performance of all U.S. equity securities with readily available price data. The index was named after the nearly 5,000 stocks it contained when it was originally created in 1974, but it has grown to include over 5,000 issues. This index includes dividends and dis- tributions, but does not reflect fees, brokerage commissions, withholding taxes, or other expenses of investing. The information provided in this material should not be considered a recommendation to purchase or sell any particular security. It should not be assumed that any security transactions, holdings, or sectors discussed were or will be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment perform- ance discussed herein. International and emerging markets investing is subject to certain risks such as currency fluctuation and social and political changes; such risks may result in greater share price volatility. Strategies discussed are subject to change at any time by the investment manager in its discretion due to market conditions or opportunities. Please note that all indices are unmanaged and are not available for direct investment. Past performance is not a guarantee of future results. No investment strategy can assure a profit or protect against loss. The foregoing reflects the thoughts and opinions of Brandes Investment Partners® exclusively and is subject to change without notice. 0409 Brandes Investment Partners® is a registered trademark of Brandes Investment Partners, L.P. in the United States and Canada.

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