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The benchmark cop-out

The failure of imagination in picking a category average as a fund benchmark.

The benchmark cop-out

According to Morningstar data, there are 37 funds in the ASISA global multi-asset flexible category. Between them, they have 28 different benchmarks.

This is understandable in a category where funds are largely unrestricted in their asset allocations. Some have chosen a composite multi-asset benchmark, which should mirror their strategic asset allocation, while others have cash or inflation-linked benchmarks.

The most commonly used benchmark, however, is also the least useful. That is the ASISA category average.

Fund objectives

In a category where almost every fund is managed to a different mandate, it is worth asking what value there is in measuring anything against their average return. What use is there in finding the average between a fund that is benchmarked against South African inflation and one that is benchmarked against the MSCI World Index, for example?

Having this as a benchmark is not just unimaginative. It tells an investor nothing about what the fund is trying to achieve.

This is evidenced just by looking at the fact sheets of two of the funds in this category that are benchmarked against the category average. One has as its objective to ‘maximise long term returns’. The other targets ‘a moderate long-term total return’.

Besides the nebulous concepts of ‘maximised’ or ‘moderate’ returns, which are themselves largely uninformative without context, here are two funds, in the same category, with the same benchmark, apparently pursuing different objectives.

Does the benchmark therefore have any value for investors?

Specifics

In the same category, the Foord International Feeder fund presents the very specific target of achieving ‘meaningful inflation-beating US dollar returns over rolling five-year periods’. This not only gives investors a clear idea of exactly what the fund manager is hoping to achieve, but also gives the manager something concrete around which to manage the fund.

Achieving a inflation-beating return is also something of value to an investor. It is a measure that they are growing their money in real terms. However, does any definite value accrue to an investor by beating the category average?

That question remains relevant even in a category where funds are more homogeneous.

Equity funds

According to Morningstar 22 of the 174 funds in the ASISA South Africa equity general category have the category average as their benchmark. This includes four of the country’s eight largest equity funds. In total, 30% of all assets in this category are benchmarked against the category average.

That makes it the most important benchmark in this category, followed by the Capped SWIX. Only 27% of assets are benchmarked against that index.

It is worth noting that the category average has been the least challenging of any the most widely used benchmarks to beat. Over both the past five and 10 years, it has under-performed all of the major FTSE/JSE equity indices, apart from the Shariah Top 40.

Questions

But even on top of this, using the category average has three fundamental shortcomings in a category like this. The first is that it doesn’t represent the manager’s opportunity set. Equity managers don’t invest in other equity funds, they invest in the stock market. They should therefore be judging themselves relative to a market index.

Secondly, the days of active managers being measured only against other active managers are gone. Being better than the average is not necessarily a sign of adding value. Index trackers are consistently better than average too.

The final issue, which is linked to that, is the problem that a category average is not investible. It does not present a fund selector with a reasonable alternative investment, and therefore no obvious way for them to determine the relative value being added.

It is also worth noting that South Africa is an outlier on this issue. It is extremely unusual to find funds benchmarked against a category average in major mutual fund markets.

Local asset managers who persist with this practice should perhaps interrogate why that is. Is there really any benefit to either themselves or their clients by doing things this way? 

 

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