Benchmarking Investment Fund Performance for the Multiperiod Investor

Abstract

Investment funds report periodic return performance, usually compared to a benchmark. However, under ICAPM intertemporal investing theory, investors are not just concerned with the current return. Rather, they look to fund performance as a projection to the future, and that involves understanding the hedge that a fund provides against loss to wealth in the future. Accordingly, this paper applies a two-factor ICAPM to examine the hedge exposure of a wide variety of investment funds. That benchmark produces a new metric for evaluating funds, one that redefines investment style. In doing so, the paper provides a new metric for abnormal performance, the alpha earned after supplying the desired hedge rather than performance relative to a one-period return benchmark. With these metrics, fund comparisons based on standard metrics are revised. For example, the paper reports that the well-documented lower performance for managed equity funds relative to the index is explained in part by these funds providing the hedging insurance, for insurance comes with a cost. The metrics distinguish popular fund styles such as Value versus Growth funds and identify the hedging features of active versus passive funds, ETFs versus other equity funds, real estate funds, and funds nominating themselves as hedge funds.