Measurement becomes meaningless
Forget the benchmark – don’t lose my money
firstname.lastname@example.org BENCHMARKS. In this sort of market do they really mean anything? It’s how fund managers are compared and often, unfortunately, is used by investors to choose a particular fund. But the relevance of benchmarks has to be questioned. I remember – some years ago, during the last bear market – being at a retirement fund seminar where two of South Africa’s largest life companies were boasting about how their funds had beaten the benchmark. Truth of the matter is that both funds delivered substantial negative returns over the year; but that didn’t seem important. What was important was that the funds had beaten the benchmark. The fact clients in the funds were 20% or so poorer also didn’t seem to matter.
Okay, we need some sort of measurement of fund performance. Peer review isn’t ideal either. For many reasons that have little to do with investment skill a fund can be top of the charts for a short while, only to sink to the bottom six months later. So, generally, the market or an index linked to it is used as the measure.
It’s probably alright in a raging bull market when the all-share index, probably the most common benchmark for equity funds, is up by 30% and a fund can say it beat the benchmark by 10 percentage points. Clients have made real money, more than they would have in a lower fee-tracker fund. If it weren’t for active managers (at least some) being able to beat the market, we’d all be in passive tracker funds.
But when the all-share index loses around 23%, as it did last year, it sounds hollow to brag about beating the benchmark. The fund lost 15%: that’s substantial outperformance of the benchmark but clients have lost money.
One problem with benchmarks is that performance based against them is historical. Though a fund might have beaten the benchmark last year is that any indication it will beat the benchmark this year? None at all. But that’s often what informs investors’ choice of funds.
An argument could be made for consistency over a longer period. A fund that’s regularly outperformed the benchmark for a number of years should have a better chance of repeating that performance, more so than the fund that’s suddenly at the top of the rankings. But even then it’s only a rough guide and no guarantee that you’re buying the best fund.
Benchmarks become positively dangerous when linked to performance fees. I always fear that might encourage the manager to take unwarranted risks, especially if his remuneration is linked to the performance fee.
A much better guide for potential investors in funds is to find if – and how much – of the fund manager’s own money is in the fund. That’s a measure I can feel comfortable with. If the manager’s money is right along mine in the fund it should mean he’ll try and get the best returns at minimum risk. Understand the fund and understand the manager. You’ll get richer or poorer together.
About the most honest benchmark a fund can currently offer is to not lose clients’ money. A more ambitious benchmark for an equity fund could be to beat cash in the bank. Not many funds did that last year.