Articles

Index Variation And Overall Portfolio Performance
By Craig Israelsen

Page 5 of 6

There are several interesting findings at the "sum," or portfolio, level. For instance, the value indexes from Morningstar (large cap, midcap and small cap) generated the best 10-year multi-asset portfolio performance among the five index providers. The value indexes from S&P/Citigroup generated the worst performance. However, the performance difference between a 12-asset portfolio using three Morningstar U.S. equity value indexes and a 12-asset portfolio using three S&P/Citigroup U.S. equity value indexes was only 19 bps (with a nearly equivalent standard deviation of annual returns). Nineteen basis points is not a dramatic difference in performance, but provides an indication that the Morningstar methodology for assembling value equity indexes is slightly more effective within a multi-asset portfolio than are S&P value indexes (at least, over this particular 10-year period from 2002 to 2011). Going forward, it is impossible to know if Morningstar's slight advantage within "value" indexes will persist. The Morningstar performance advantage over S&P when utilizing three value indexes (large-cap, midcap and small-cap) within a 12-asset portfolio was partially attributable to the performance of the Morningstar large-cap value and small-cap value indexes. In midcaps, however, the S&P Midcap 400/Citigroup Value Index actually had better 10-year performance than the Morningstar Mid Value Index.

When using blend indexes from the five index providers in a 12-asset portfolio, we observe that the Dow Jones indexes generated the best performance, posting a 9.11 percent 10-year average annualized return. When S&P U.S. equity blend indexes were utilized in the 12-asset portfolio, the 10-year annualized return was 8.98 percent, a mere 13 bps behind. However, the standard deviation of the annual portfolio returns was slightly lower using the S&P indexes (15.3 percent vs. 15.9 percent). When considering both risk and return, the Dow Jones U.S. blend equity indexes and the S&P U.S. equity blend indexes produced results that were comparable.

The least attractive blend indexes to utilize in a broadly diversified 12-asset portfolio were from Morningstar (based on the 10-year period from 2002-2011). However, these are narrow margins of difference between best- and worst-blend indexes. Only 19 bps separated the best 10-year performance (Dow Jones indexes) from the worst (Morningstar indexes). Pragmatically speaking, using the U.S. equity blend indexes (large, mid and small) from any of the five index providers produced comparable, and satisfactory, results.

Performance at the portfolio level when using growth indexes from the various index providers was identical to the blend rankings: Dow Jones was first, S&P/Citigroup was second, MSCI was third, Russell was fourth and Morningstar was fifth. In this case, the differential in performance between first and fifth place was larger than when using blend indexes. The Dow Jones growth indexes contributed to the 12-asset portfolio in such a way as to generate a 10-year annualized return that was 65 bps larger than if using three Morningstar growth indexes.

When using the three growth indexes from S&P/Citigroup, the 12-asset portfolio had a 10-year annualized return that was 19 bps behind the 12-asset portfolio using Dow Jones growth indexes. However, the S&P growth indexes produced a portfolio standard deviation of 15.3 percent compared with 16.6 percent using the three Dow Jones indexes. This change represents an 8.5 percent reduction in annual return volatility. Worthy of note is the fact that three S&P U.S. equity growth indexes (large, mid and small) contributed to the lowest portfolio standard deviation of return among the five index providers by a fairly sizable margin.