Question

. Your firm is managing 4 investment products with the following characteristics:

              

               Equity Standard

200 stocks

P/E= 1.05x that of the broad market

D/E= 0.95x that of the broad market

All Economic Sectors

Total assets under management= $ 2.5 billion

               Value Dynamics

110 stocks

P/E= 2.0x that of the broad market

D/E= 85 percentile of the broad market

Overweight in technology, health care and housing sector

Total assets under management = $ 1.5 billion

               Blue Growth

125 stocks

P/E= 0.75x that of the broad market

D/E= 35 percentile of the broad market

Overweight in consumer staples, utilities, and closed end funds

Total assets under management = $ 4.5 billion

               Fixed Income Plus

250 bonds

50% invested in government bonds, half in maturities below 10 years and the rest with maturities above 10 year

25% invested in US Corporate Bonds. 75% of the US Corporates invested in Investment grade bonds and the rest in high yield bonds.

25% in international bonds, half of it in developed markets and the other half in emerging markets

Total assets under management = $ 5.0 billion

               Global Growth

This product is a combination of the above four products.

Total assets under management = $ 7.5 billion

1.             Design a benchmark to measure the performance of each of the products above.
2.             Define and justify each component of the benchmarks.

Answer 1

Summary:

Designing a relevant benchmark mainly depends on various factors considered by the asset management company while creating the investment products. The five investment products listed above follow unique investment strategies with respect to the sectors of investment and the asset class (equity/debt/mixed).

Classification:

Following is the classification of the investment products based on asset class:

• Equity only:
  • Equity Standard (AUM $ 2.5 billion)
  • Value Dynamics (AUM $ 1.5 billion)
  • Blue Growth ($ 4.5 billion)
• Debt only:
  • Fixed Income Plus ($ 5.0 billion)
• Mixed (contains both equity and debt):
  • Global Growth ($ 7.5 billion)

Benchmarks

1. Equity Standard (AUM $ 2.5 billion)

The Equity Standard investment product invests in 200 stocks across all economic sectors. The best benchmark to measure the performance of this product would be market indices which usually are a mix of all sectors and provides an excellent guide to adjudje the performance of the product versus the index performance. Examples : S&P 500, STOXX Europe 600, etc

2. Value Dynamics (AUM $ 1.5 billion)

The Value Dynamics investment product invests in 110 stocks with major weightage on sectors such as technology, health care and housing. Since all the three sectors are in different area of business, no single benchmark in the existing markets would suffice as a relevant reference to asses the performance. The creation of a composite benchmark with 33.3% weights to indices representing each of these sectors would ensure a fair comparison of the performance metrics. The example of indices to be considered for the purpose are as follows: Dow Jones U.S. Technology Index (For Technology sector), S&P 500 Health Care (For Health care sector) and Dow Jones U.S. Real Estate Index (For Housing sector).

3. Blue Growth ($ 4.5 billion)

The Blue Growth  investment product invests in 125 stocks with major weightage on sectors such as consumer staples, utilities, and closed end funds. Advisable to create a benchmark based on the industry specific indices and assigning 33.3% weightages to ensure equal representation of these sectors.

4. Fixed Income Plus ($ 5.0 billion)

The Fixed Income Plus investment product invests in 250 bonds mainly consisting of US govt. bonds (50%) and then US corporate (25%) and International bonds (25%). There 'S&P U.S. Treasury Bond Index' serves as a benchmark for US govt. bonds performance, the 'S&P 500 Investment Grade Corporate Bond Index' serves as a benchmark for US corporate bonds. Since there is no single index tracking the perfromance of international bonds, the benchmark should consider the rough average of the developed markets like Europe to get to the right mix. The rest metrics for weight remain in proportion with the composition of the investment product (US govt bonds 50% weight) (US corp bond 25% weight).

5. Global Growth ($ 7.5 billion)

The Global Growth product is a combination of all the above products. Designing the benchmark for this product would include weighted average of all the above products in their respective benchmarks to arrive at the benchmark to assess the performance of the Global Growth product.

Thank you !