![\"RETURNS_OF_VARIOUS_BENCHMARK_1999-2011.jpg\"](\"http:\/\/beta.next-finance.net\/wp-content\/uploads\/2012\/11\/RETURNS_OF_VARIOUS_BENCHMARK_1999-2011.jpg\")
<\/p>\nAsk any active fund manager about his benchmark, and he
\nwill have a ready-made answer. US equity managers will find
\nit convenient to benchmark themselves against the S&P 500.
\nEuropean equity managers will likely invoke the Eurostoxx 50
\nas their main market gauge. Even fixed-income managers
\nhave plenty of indices to choose from, regardless of their
\nlocation. The call is trickier for diversified fund managers,
\nor for investors such as pension funds taking strategic
\nexposure to financial markets as a whole, as opposed to
\na single asset class. In the absence of multi-asset class
\nmarket indices, arbitrary benchmark choices have been
\nmade. The understanding of the performance generated by
\nthese investors is deeply affected.<\/p>\n
A quick look at the benchmarks used by these investors
\nreveals a particular inclination for the 50\/50 or 60\/40
\nconstant mix allocation in equity and fixed income. This is
\npartly the legacy of the twenty years up to the 21st century,
\nwhen markets featured a somewhat similar asset split.
\nThe evolution of financial markets over the last ten years has
\nmade such benchmark choices little indicative of the market
\ncomposition at any point in time. New multi-indexation
\ntechniques taking into account yet to be launched stock
\nand bonds indices would allow doing it much more.<\/p>\n
Both fund managers and investors are at a loss when referring
\nto the market portfolio. Even if under the CAPM theory the
\nmarket portfolio is made up of an asset mix based on the
\nmarket capitalization of equities and bonds, diversified fund
\nmanagers are generally benchmarked against a constant
\nmix portfolio. As such, they express their bets with respect
\nto this constant mix benchmark, which turns out to be itself
\nand active bet with respect to the market.<\/p>\n
It is easy to fault the absence of multi-asset class indices for
\nthis apparent carelessness. But given the wealth of data on
\nequity and fixed income markets enabling the construction
\nof accurate multi-asset class indices, the investment
\nmanagement industry now has little excuse for perpetuating
\nsuch behavior.<\/p>\n
A look at the stock\/bond market portfolio, which accounts
\nfor almost all of the performance of long-term investors,
\nshows that the market portfolio has been subject to wild
\nswings over the last ten years. This applies to most regional
\nmarkets and has direct implication in terms of performance
\nassessment.<\/p>\n
For instance, the weight of the equity market with respect
\nto the entire market capitalization for sovereign bonds
\nand equities in the US reached 89% in September 2000,
\nwhereas it was 55% in December 1987. There are also wide
\ndifferences between countries. During the nineties, the
\nequity weight increased in the US whereas it decreased for
\nJapan. The split is also very different in Germany and France
\nfrom the US and the UK. In March 2012, the equity weight
\nwas 68% for US, 32% for Japan, 51% for Germany, 54%
\nfor France and 66% for the UK. If investment grade bonds are taken into account, the breakdown is 50\/50 in the US
\nand 35\/65 in the eurozone. At the beginning of 2000s, these
\nfigures were respectively 70\/30 and 65\/35.<\/p>\n
These results show that it is impossible to characterize the
\nmarket portfolio by fixed weights, as diversified managers
\nand pension funds have long become used to. Doing so
\nimplies that a manager with a supposedly neutral market
\nexposure by sticking to its 50\/50 or 40\/60 allocation is in fact
\ntaking a bullish or bearish view on the market, depending on
\nthe real asset split of the market. It also means that the alpha
\nthat some diversified managers may claim to have generated
\nmight be nothing else than pure market beta.<\/p>\n
<\/p>\n
Given the wealth of market data now available, more realistic
\nbenchmark indices should be elaborated to benchmark
\ndiversified funds and asset allocators in general. The implications
\nin terms of performance analysis would be considerable.<\/p>\n
The performance analysis of a risk parity strategy allocating
\namongst equity and fixed-income of developed countries
\nusing various benchmark is a case in point. For the period
\n1999-2011, benchmarked against the 60\/40 portfolio, the
\nannualized alpha and the tracking error volatility of this
\nrisk parity strategy come at 72 bps and 7.80%, with an
\ninformation ratio at 9.2%. Benchmarked against a 30\/70 portfolio, which is more representative of the traditional
\nportfolio of large institutional investors in the eurozone, the
\nsame information ratio is 5.4%. By now, it should be obvious
\nthat a 50\/50 would also result in a different information ratio.
\nIn order to avoid these arbitrary choices of benchmark, the
\nmost rational choice is to use the market portfolio. In this
\ncase, the information ratio is equal to 17.75%, highlighting the
\nvalue created by this risk parity strategy.<\/p>\n
As well, multi-asset class indices would help to better assess
\nthe performance and bets of long-term investors such as
\npension funds or sovereign wealth funds. For instance, for a
\npension fund, a 60\/40 asset mix policy was a negative bet on
\nequity in 1999, but a positive bet today.<\/p>\n
Today, it is unthinkable to manage an equity or a fixedincome
\nportfolio without a reference to a single asset class
\nbenchmark. It is now time for index providers to launch similar
\nindexes representing the stock\/bond market portfolio, even
\nif this enterprise that is likely to be fraught with difficulties
\ngiven the split between fixed income and equity indices
\nproviders
<\/a>\n\t\t\t<\/div><\/figure>\n\t\t<\/div>\n\n","protected":false},"excerpt":{"rendered":"