- Investable
- Realistic
- Replicable
- a reflection of the fund’s investable universe
Unfortunately there are numerous funds out there that have benchmarks that fail these key attributes and have benchmarks based on marketing or investor needs. For example, many hedge funds have had an annual positive return benchmark even though they are largely exposed to equity or credit markets.
This week I have seen global listed infrastructure funds that benchmark to CPI plus x% and this is also the case for numerous multi-manager investment funds and the benchmark of asset allocations set by the numerous asset consultants and research agencies.
What a ludicrous benchmark CPI plus or annual positive return benchmarks are for funds that are exposed to equity markets. High inflation is not good for equities and neither is deflation so the relationship is weak. If I want to beat CPI I can just invest in an inflation linked bonds.
Equity markets are so volatile that at any stage the equity markets will be outperforming a stated positive return so a positive return benchmark is surely just a way of increasing fees for the manager on the back of the belief in the equity premium.
Overall, if a fund’s benchmark does not reflect their investible universe and it cannot be replicated for investment then the fund will be dismissed by me. The role of an active manager is to outperform its benchmark after adjusting for risk (and fees). When a benchmark doesn’t reflect a fund’s actual risk then iits time to dismiss the fund as an investment consideration.