Question

Investment fund performance can be evaluated against three different benchmarks: a market index, a benchmark normal portfolio or the median of the fund’s manager universe.

Explain two different weaknesses of using each of the three different benchmarks to measure fund performance.   

Answer 1

Market Index

· For market index to be benchmark the constituents should be same or the risk should be same which is not feasible for a small portfolio.

· The transaction should be taken into account but for a market index portfolio it is often ignored.

Benchmark Index

· In real world it is very difficult to find precise benchmark with which the performance can be compared, so similar risk index is used.

· The benchmark also suffers the same constituent issue as well as they can also have other risk like currency exchange, if the benchmark is taken from another country.

Median funds manager

· Median performance can not always be relied upon if the fee charged by the fund manager is high comparatively high, then the performance should not be mediocre.

· The trading style of investment should also match and not just the median performance because trading style can affect the risk and return in the short run as well as long run.