Benchmarking Benchmarks: Much Ado About Nothing
41 Pages Posted: 8 Dec 2015
Date Written: June 28, 2013
We compare the performance of a wide variety of benchmarks: traditional, fundamentals-based and optimization-based. We find that for a set of all stocks of the S&P500 index during the period from February 1989 to December 2011 traditional and new benchmark portfolios perform similarly according to a variety of return, risk, turnover, and diversification performance metrics. Moreover, the difference between traditional value- or equal-weighted benchmark and new benchmark portfolios is not statistically significant. We identify a set of basis benchmarks, which span both the set of new and the set of traditional benchmarks. The first basis benchmark explains three quarters of the variation of all benchmark portfolios; correlation between this basis benchmark and systematic market factor is 96% for the last 10 years period. We conclude that the strongest driving force of all considered benchmark portfolios is the market factor. Irrespective of the benchmark portfolio, managers mainly track the market and do it in statistically sufficient way during the last 23 years. The difference in the performance of various benchmarks can be attributed to the skill to outperform the market. In the long run these skills are washed out. Our work has implications for big mutual, pension and hedge funds with fairly big number of stocks in their portfolios and long investment time horizon. For these funds the choice of the benchmark is not important.
Keywords: benchmarking, fundamentals-based index, equal-risk contribution, minimum-variance, portfolio optimization, market efficiency
JEL Classification: G11, G12, G14
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