As James Montier points out – Benchmarking, like most bad ideas, most likely started out with good intentions, an attempt to monitor the performance of investment managers.
Unfortunately, most of us who manage real money live in a relative world and we are measured and paid by benchmarks. One day the industry will likely move towards absolute benchmarks, most likely when clients are sick of being told they’ve “lost money – but not QUITE as much as you’d have lost had you invested in this arbitrary hypothetical portfolio!”.
I really want to emphasise that I think investors should let market weightings, market cap and asset allocations be “Servants and not Guides”. Benchmarking has morphed into an unhealthy obsession within the asset/wealth management industry. Whole teams of “specialists” are employed to pigeon-hole managers into niches and to categorise things that are often uncategorizable. In my opinion, too much focus is on the minutiae of which fund goes where and what geography or style they adhere to and how that “blends” with other managers in the portfolio. For those constructing a portfolio of managers or funds I ask – what’s wrong with choosing with the “Best” 10 allocators of capital you can find and letting them get on with it?! I’d rather have a dream team of managers that can go anywhere than make sure I have a “man on the ground” in every geography regardless of the opportunity set.
From a stock perspective, I was flabbergasted recently (I shouldn’t have been!) when someone tried to argue to me with me that having a 5% position in a certain stock was actually a bearish position! I’m sorry, but having 5% of MY capital in something is a strong statement on my behalf that I believe that stock is trading for considerably less than it is worth! Of course, what I naively failed to comprehend was that this particular stock comprised 6% of it’s index. Sigh! These are the same people who will complain about stock specific risk if you owned a 6% position in any other company in that same index.
I am reminded of the quote “It’s very hard to get a man to understand something when his salary depends on him not understanding it.”
To me, the benchmark provides an indication of risk tolerance – nothing more. It is a framework/sense check as to whether one is taking too much risk or not. When (and I shudder) “populating portfolios” I think it is important to remember that a manager’s duty is to the client, to enhancing the value of their investments and delivering them good advice and service, our duty is NOT to the benchmark. As Sir John Templeton said “there is only one long term investment objective, maximum total returns after tax.”
Controversially, I might suggest that the reason the asset management industry has become so obsessed with multi-asset class benchmarks is because of the reduction in absolute volatility brought about by adding “cash” and “hedge funds” and “property” into all portfolios. This reduction in volatility means reduced volatility in portfolio values, which is assets under management, which is the predominant determinant of the asset manager’s earnings! Less volatile earnings streams are surely worth a higher multiple right?
Personally, I benchmark my own portfolio against 2 things – The FTSE All-Share and the HFRX Hedge Fund Index but I use these merely as a measure of the “Opportunity Cost” I may have incurred. I also approve of the Longleaf Partners approach of CPI +10% (beat that!!). I have a completely unconstrained approach to investing, trying to maximise my returns without taking on undue risk to either the long or short side.
Benchmark? I just want to make money! I’ll side with these guys…
“We have this investment discipline of waiting for a fat pitch. If I was offered the chance to go into business where people would measure me against benchmarks, force me to be fully invested, crawl around looking over my shoulder, etc., I would hate it. I would regard it as putting me into shackles.” Warren Buffett
“The Berkshire-style investors tend to be less diversified than other people. The academics have done a terrible disservice to intelligent investors by glorifying the idea of diversification. Because I just think the whole concept is literally almost insane. It emphasizes feeling good about not having your investment results depart very much from average investment results” Charlie Munger
“If you buy the same securities as other people, you will have the same results as other people. It is impossible to produce a superior performance unless you do something different from the majority. To buy when others are despondently selling and to sell when others are greedily buying requires the greatest fortitude and pays the greatest reward” Sir John Templeton
“This idea of benchmarking has morphed into an unhealthy obsession with pigeon-holing managers into niche buckets. So while an investable benchmark makes measuring performance an easy task, it isn’t necessarily good for focusing the manager’s mind on generating real returns. Relative benchmarks are often employed to the detriment of real returns and the preservation of capital.” James Montier (Member of GMO’s Asset Allocation Committee)
“Performance measurement is one of those basically good ideas that somehow got totally out of control. In many cases, the intense application of performance measurement techniques has actually served to impede the purpose it is supposed to serve – that of good performance” Bob Kirby
Having worked as a long only equity PM for 12 years, I must say I really enjoyed your post. I think you nailed the issues and frustrations of the role. My own view is that asset gatherers (banks/insurance co’s etc) should be prohibited from owning investment management firms – this may force the industry to buy in the best products that are suitable given a set of conditions. However, even independent firms are addicted to the benchmark or peer group. In Ireland there are even something called ‘consensus funds’ which actually track the holdings/asset allocation of a prescribed peer group and just follow that.
Given the situation across many markets since the turn of the century I am surprised at how resilient the long only relative fund manager has been. I would have thought that there would be more ways for the ordinary joe to access absolute return funds. Only issue I see is that there are very few true absolute return funds – many from what I see are simply ST momentum traders.
Anyway, great post. Keep it up please.