Performance Measurement- Benchmarking and Attribution Analysis 

Our Asset Allocation Division also guides investors in analyzing the performance of various assets or fund managers against appropriate benchmarks. Most often, as an industry practice, an universe or peer group performance is treated as a benchmark against which the performance of a fund manager is evaluated. We believe that this is not an appropriate benchmark as ideally a benchmark should be unambiguous, measurable, investable, reflective of current investment opinions and specified in advance (see CFA Institute's guidelines). Broad market indices such as the S&P 500, Russell 3000, Wilshire 5000 etc. are not good benchmarks for most active non-large core managers. Even style indices such as the Russell 1000 Growth, 1000 Value, 2000 Growth, or 2000 Value are not appropriate for the vast majority of managers. Similarly, manager universes are not investable, not specified in advance, and since they are made up of active managers they are not the passive equivalent of an active manager. Additionally, manager universes suffer from survivorship bias (the poor performing managers drop out and/ or are merged with better performing funds). Most importantly, they are usually too broadly defined to accurately judge the skill of a specific manager. In order to avoid these common errors, we develop customized policy benchmarks that are truly reflective of a client's Investment Policy Objectives and Asset Allocation Strategy.  A custom benchmark is a composite benchmark that is produced by weighting a set of asset class indices that appropriately captures both market systematic factors and managers' skills within a risk-return optimization framework. 

Once the custom benchmark is built, it is easier for us to evaluate the performance of a fund manager against it and segregate a fund manager's performance that is attributable to his idiosyncratic skills or style such as investing in the right style, active stock-picking, sector bets, or market timing from the general market or asset class performance. Moreover, a manager's performance may have the end-point bias or broken clock syndrome. When a manager’s recent performance is good, cumulative analysis tends to make its longer term performance look good, regardless of past performance as recent good performance hides past bad performance. For example, Morningstar’s star ratings are based on fund’s performance relative to a broad group of fund returns, as opposed to a more specific benchmark that reflects the manager's true style. 

Because of this, on February 28, 2000, at the very peak of the growth stock bubble, most of Morningstar’s five star funds were growth funds while there were no five star value funds. Two years later, after the value funds did well and the growth funds crashed, most of the five star funds were value funds. 

In order to avoid this, we perform attribution analysis over various rolling-windows of say 12 months to 36 months both on in-sample and out-of-sample basis using the Bayesian Black-Litterman Approach. This helps us not only to segregate manager's skill or style but also to identify his source of active alpha and consistency in achieving such active alpha over a longer period of time.  

We follow an elaborate performance measurement process in selecting funds within each asset class or investment style. You can have a look at the following presentations to review our approach before we evaluate the fund managers under the various categories: - 

Equity Value Indices Screening and Analysis July 2006;

Equity Growth Indices Screening and Analysis July 2006;

Hedge Fund Screening and Analysis July 2006.  

Should you require further information on our asset allocation strategy or review asset class/manager-wise performance analysis or have specific asset allocation or product development requirements, kindly contact us at smartam@smartinternationalholdings.org.

Related Areas: Global Investment Strategy, Global Asset Allocation Strategy, Product Development- Investment Products and Managed Accounts, Wealth Management Strategy.