Chasing Two Rabbits: Challenges in Benchmarking Liquid Alternatives
The Journal of Index Investing 6, 80-85, 2015
Posted: 9 Dec 2015
Date Written: June 1, 2015
Liquid alternatives are required to compare their performance to a broad-based market index. Despite their objective to offer low correlations with equity returns, these funds provide traditional equity indexes as benchmarks 2.5 times more than any other benchmark category. By pursuing strategies unrelated to their primary benchmarks, liquid alternatives can generate significant tracking errors, which cause biased information ratios. We review the challenges of benchmarking liquid alternatives and recommend use of the downside deviation or maximum drawdown. This issue is important as research shows how performance relative to even a mismatched benchmark is a significant determinant of fund flows.
Keywords: Liquid Alternatives, Benchmark
JEL Classification: G20
Suggested Citation: Suggested Citation