By Emily Hollis
Modern portfolio theory relies on total return, but in what situations is total return relevant and appropriate for your credit union? The answer depends on your portfolio, your assessment preference and the knowledge you wish to obtain concerning your investments. A financial advisor clears up some of the confusion.
Modern portfolio theory dictates that regardless of a portfolio’s strategy – whether it’s buy-andhold,
indexed, leveraged, actively managed or another method – the total return and its variability are the “holy grail” of performance measurement. Total return is also the basis for calculations like the information ratio and value at risk (VAR), which are tools to value portfolio returns and the risk of loss. Total return is not a portfolio strategy; rather, it is a long-run performance measurement that captures all reinvested cash flow and the opportunity costs of being in or out of different asset classes.
Although total return tends to be used for available-forsale portfolios, it also can be useful if credit unions designate securities as held-to-maturity. This decision depends on whether or not the credit union wants to assess a true return on investment or a method to calculate performance of a set
investment portfolio. If a credit union never plans to sell, or if it uses investments to support the loan portfolio, total return may not be relevant. Similarly, if the investor merely wants to know if one investment was a better choice than another, total return may or may not be appropriate.