Interpreting the return index graph

The return index graph in Sharesight has a start value of 10,000 points. The index can be interpreted as showing the growth of a $10,000 investment assuming that you were able to achieve your annualised percentage return on a fixed $10,000 investment for the duration of the reporting period. In situations where you have a relatively constant sum of money invested for the duration of the reporting period this graph provides a useful visualisation of how your holding or portfolio has grown over time. By applying a benchmark you can visualise portfolio performance against a benchmark.

Where there is variation in the amount of capital invested during the reporting period the indexation process results in a degree of extrapolation due to the assumption that you were able to achieve your per annum return on a fixed sum of money invested for the entire reporting period. The degree of extrapolation depends upon the extent to which the amount of capital invested varies during the period of investment. Due to price volatility such extrapolation may be considered unreasonable in some cases on the basis that maintaining your return on a fixed sum for the duration of the period is unrealistic. The Return Index graph should therefore be used with caution where the amount of capital varies significantly. Examples of this include:

• where a portfolio or holding is fully or partially sold down during the reporting period
• where significant additional capital is added within the reporting period

To illustrate the points above, the following examples illustrate two scenarios where an investor has invested in an ETF and has opted to benchmark the performance of his holding against the ETF itself.

Example 1 - Comparing a return index where a fixed amount of capital is invested

In this example the investor has opted to invest a fixed sum of money in the STW fund and benchmark the performance of the holding against the fund itself. As expected the performance index is the same for both the holding and the benchmark.

Image notes:

1. A single buy trade of approx $10,000 has been recorded

2. As expected, the performance index line is exactly the same for the holding and the benchmark (the two index lines are plotted on top of each other).

3 & 4. The index value (4) shows that a fixed investment of $10,000 would have increased to $25,846 by the end of the period, representing a dollar gain of $15,846. This corresponds with the dollar gain for this holding (3) as the investor also invested $10,000.

Example 2 - Comparing a return index where a variable amount of capital is invested

This is an extreme example that illustrates a significant variation in the amount of capital invested As per Example 1 the investor has opted to invest in the STW fund and benchmark the performance of the holding against the fund itself, however in this example the investor has sold down the majority of their holding after the first year. Because the fund achieved a higher than average return in the first year, the investors per annum return is higher than that of the fund itself.¹

In this example the performance index shows the the growth of a $10,000 investment assuming that the investor was able to achieve their higher return on a fixed amount for the duration of the reporting period.

Image notes:

1. The $10,000 buy trade is the same as in Example 1, however an additional sell trade sell trade has sold down the majority of the investment after the first year leaving only a very small amount invested for the remainder of the period.

2. The performance index line follows the benchmark index for the first year and then extrapolates this growth for the remainder of the reporting period ( note: the return on the small amount of capital invested for the remainder of the period is considered, but has a low weighting). Although it may seem inappropriate to extrapolate the return when the performance of the fund is known, if the return were not extrapolated in this way then in this example the return index for the holding always match the benchmark¹. It’s important to note that the return index does not relate to the actual dollar growth of the portfolio where the capital invested varies within the reporting period.

3 & 4. The index value (4) shows that a fixed investment of $10,000 would have increased to $69,897 by the end of the period. This does not correspond with the dollar gain for this holding (3) since the the majority of the $10,000 investment was only invested for a one year period.

¹ Sharesight uses a dollar weighted return methodology to calculate percentage returns. This takes account of the timing and value of your buy and sell trades. In other words your decisions about when to buy and sell influence your return. Using a dollar weighted methodology, it’s possible to outperform the overall return of an ETF by solely investing in the ETF, providing that you time your trades such that your money is primarily invested during periods of higher growth. For further information, read about Sharesight’s performance calculation methodology.

Last modified on August 19, 2021 UTC