How you doin'?: Benchmark returns
Endowus Insights

How you doin'?: Benchmark returns

August 17, 2018
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Thank you for participating in our Yayoi Kusama 'count the dots' market efficiency challenge last week. You can read that article here. The results were surprising:

Range of Answers: 300 to 50,000
Average: 7,005
Actual: 7,390

Switching gears, a new study by the Index Industry Association (IIA) reports that there are 43,000+ public companies in the world and 3.3 million+ stock market indices. That is 70x more indices than public companies, and it's absurd.

When a trader brags to you that their fund or portfolio is beating benchmark, question what benchmark they are using. Many have been created in recent years by active fund managers so they can label their funds as "benchmark beating". It's like saying that you're smarter than average - however the average is arbitrary. You've got one of the highest hurdles to beat if you're comparing yourself to Singaporeans (average IQ: 103), but is IQ even a valid scale to judge 'smartness'? What makes an astrophysicist intelligent may be fairly useless on the African savannah.

So how do we navigate this deceptive world? First, we have to understand why we benchmark. A benchmark can help you evaluate your portfolio and answer these questions:

  • Is there a cheaper, better and easier way to gain this exposure?
  • Am I taking too much risk to earn these returns?
  • Are my investments in-line with my goals?

We are competitive creatures and like to know where we stand, but many of us get caught up measuring our portfolio performance to a benchmark such as the S&P500, whether or not it may be the appropriate benchmark to use.

Having a benchmark is only useful if it's an appropriate yardstick.

Say you are entirely invested in 2 US stocks - Tesla and a small cap company that just listed called ABC Blockchain - and you claim to have beat the S&P500. Is the S&P 500 even relevant in this discussion? We think not, as your risk is on a different scale altogether.

Understand the composition of your benchmark. The S&P500 for example is a market-cap weighted index of 500 large-cap companies in the US, where the 4 tech giants (Apple, Microsoft, Amazon, Facebook) make up > 11% of the index. The Dow Jones is a price-weighted average of 30 stocks (Amazon and Facebook are not constituents). The often discussed MSCI World Index is deceptively only large-cap developed market companies, whereas the MSCI All-Country Index has both developed and emerging markets.

Choose wisely as there are 3.3 million options, and this number is only growing rapidly as the financial services industry tries to convince us that all their funds are above benchmark.

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