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   Investment Thoughts - Academia

Curse of the Benchmarks

 

Abstract

 

Obsession with short-term performance against market cap benchmarks preordains the dysfunctionality of asset markets. The problems start when trustees hire fund managers to outperform benchmark indexes subject to limits on annual divergence. For multi-asset portfolios the benchmark is generally the performance of peer group funds, also based on market cap. In the absence of formal instructions, asset managers, as well as off-the-peg mutual funds, are still keen to demonstrate their ability against the competition in the short run.

 

If securities markets were efficiently priced in the sense of reflecting best estimates of fundamental value, there would be no problem in using market cap benchmarks. But the terms under which most professional investment is handled ensure that markets are not efficient. Benchmarking causes, first, the inversion of the relationship between risk and return so that high volatile securities and asset classes offer lower returns than low volatile ones. Second, it fosters the pursuit of momentum strategies which then earn profits at the expense of benchmarked funds. The paper explains how these problems arise using rational models of asset mispricing and proposes an incentive-based solution.

 

 

Link to the original full-text paper

 

 

 

Dimitri Vayanos, Paul Woolley, London School of Economics, Paul Woolley Centre, March 2016-Financial Markets Group, Discussion Paper, No 747

24.03.2016


 

Themes

 

Asia

Bonds

Bubbles and Crashes

Business Cycles
Central Banks

China

Commodities
Contrarian

Corporates

Creative Destruction
Credit Crunch

Currencies

Current Account

Deflation
Depression 

Equity
Europe
Financial Crisis
Fiscal Policy

Germany

Gloom and Doom
Gold

Government Debt

Historical Patterns

Household Debt
Inflation

Interest Rates

Japan

Market Timing

Misperceptions

Monetary Policy
Oil
Panics
Permabears
PIIGS
Predictions

Productivity
Real Estate

Seasonality

Sovereign Bonds
Systemic Risk

Switzerland

Tail Risk

Technology

Tipping Point
Trade Balance

U.S.A.
Uncertainty

Valuations

Yield