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Benchmarks and Performance Evaluation

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See also Mutual Funds, The Zeroes 2000-2009, and Historical Data

You can't manage what you can't measure.
William Hewlett

Gary Karz, CFA (email)
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Proficient Investment Management, LLC and InvestingAudit.com

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Trivia: According to Barr Rosenberg, how many years of observations would it take to show conclusively that even 200 basis points of incremental annual return resulted from superior investment management skill rather than chance? Answer

Background

     Benchmarks are used to determine relative performance of portfolios and securities. They are particularly useful in evaluating mutual funds and money managers. Morningstar and Lipper Analytical Services are two of the many services that track and analyze mutual fund performance. Many investment consultants also evaluate money managers and funds vis-a-vis benchmarks and other money managers and funds.

     Commonly used benchmarks for measuring US stock returns are the Wilshire 5000 for the broad market, the S&P 500 for large capitalization stocks, and the Russell 2000 for small stocks. Morgan Stanley's EAFE is commonly used for Global stocks.

     Generally, experts recommend using benchmarks that are unambiguous, investable (using a median is not an investable option), measurable, specified in advance, and are appropriate and consistent with the managers style. Still, investors should be aware that performance evaluation has two basic problems.

  1. Many observations are needed for significant results.
  2. Shifting parameters during active management complicate performance valuation.

     In addition to returns, its often helpful to analyze risk measures. The following are commonly used risk adjusted performance measures.

Trivia Answer: 70 years
Source: Investment Policy: How to Win the Loser's Game by Charles D. Ellis

See also Do Past Winners Repeat? and
Cherry-Picking: Survivorship Bias, Creation Bias and Other Performance Issues.

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