Mea­sure­ment be­comes mean­ing­less

For­get the bench­mark – don’t lose my money

Finweek English Edition - - Creating Wealth - SHAUN HAR­RIS

shaunh@fin­ 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.

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