Money Managers

Our money managers, like other investment managers and brokers, fight a constant battle with investors about realistic benchmarks for performance. The bogey that is chosen can make you and/or the managers you recommended for your client a hero or a zero, so correct selection is important. Investors usually want the bogey to be whatever index had the most spectacular performance over the past twelve months. If their small-cap manager beat their small-cap benchmark, they want to know why they didn�t beat the S&P 500. If their large-cap manager beat the S&P 500, they want to know why they didn�t beat the Nasdaq 100 or the Internet Index. If investors focus only on performance, they miss the point of the benchmarks in the first place: to assess manager skill. The whole point of a bogey is to determine whether the manager is adding value or not. The Association of Investment Management and Research (AIMR) has published the most comprehensive guidelines on performance reporting. Their general position is that the benchmark should match the type of securities in the account and the way the portfolio is constructed. Obviously, it makes no sense to benchmark an international manager against the Dow Jones, which is a domestic index. But that�s the easy part. The tricky part comes when you start to look at how the portfolio is constructed. Many common benchmarks are capitalizationweighted, but many investment managers run equal-weighted portfolios, in which each position might be 3 percent of the account, for instance. The differences between them can be dramatic. For example, many large-cap managers use the S&P 500 as a bogey. This would be absolutely reasonable if they ran a capitaliza-tion-weighted account. The Vanguard Index 500 Fund, for instance, is cap-weighted, and should be compared to a cap-weighted index to see if any value is being added. But a large-cap manager running an equal-weighted account should be benchmarked against something like the S&P 500 Unweighted Geometric, which had a 1999 performance of +3.06 percent, rather than the +21.04 percent return of the cap-weighted version. Keep in mind that the eighteen percentage points of difference reflect the performance of exactly the same 500 stocks, just weighted differently. If managers can tack on performance above the benchmark, they are adding value within their selection universe and showing some evidence of skill. A manager could reasonably be compared to the S&P SuperComposite 1500, which is cap-weighted and returned 20.26 percent for 1999, or to the Value Line Geometric, which is equal-weighted and was down 1.40 percent for the year, depending on how the portfolio is constructed. Finally, once you have the proper bogey, you need sufficient time to assess manager skill. One year, clearly, is not enough. Clocking Frank Shorter�s 100-meter time will not tell you anything about his ability to run a marathon. Statistically, thirty years would be nice to establish significance, but most investors are not likely to be that patient! The happy medium might be three, five, or ten years, depending on the investor�s style.


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