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Indices, Benchmarking and Index Investing

Recent Thinking on Benchmarking and the Use of Indices

There has been a significant shift by both retail and institutional investors to passive investment strategies in recent years. Reasons are many and varied but include cheaper fees and the fact that over time, only a small cadre of investment managers tend to outperform major indices. Massive investment flows into funds and strategies with an ESG bias has seen a plethora of new ESG related indices spring up in response.

This selection of papers covers several aspects of the indexation and benchmarking topic, including how the use of new benchmarks may aid defensive equity portfolio evaluation, and how benchmarking by managers may lead to lower expected returns from very widely held stocks. An interesting paper illustrates how, with the advent of technology, ‘custom indexation’ may become accepted across the wealth management community, particularly for portfolios with specific ESG tilts or thematic approaches.

bench with mark


Portfolio Delegation and the Effect of Benchmarks (Norges Bank, 2020)

Norges Bank, manager of the €1.12 trillion Norwegian sovereign wealth fund, explores the literature relating to portfolio delegation and the impact and influence of benchmarking in asset manager compensation and asset prices. They note that widespread benchmarking may lead to higher equilibrium prices and lower anticipated returns for assets widely included in delegated portfolios.

How a New Benchmark Adds to Defensive Equity Strategy Evaluation (Intech, 2020)

For compliance reasons, this paper is only accessible in certain geographies

Intech’s paper, originally featured in the Journal of Index Investing, demonstrates how Minimum Volatility Indices can be used to aid defensive equity strategy evaluations. Although they have some limitations, Minimum Volatility Indices may be more appropriate benchmarks for a defensive equity allocation than cap-weighted benchmarks and may assist in the evaluation of managers and their performance.

Political Risk and EM Equities: An index framework (S&P Dow Jones Indices, 2021)

S&P Dow Jones Indices collaborated with GeoQuant, an AI-driven political risk data firm to produce the 'Political Risk-Tilted Concept Index'. They find that adding political risk as a factor into EM equity allocation decisions can drive outperformance of the benchmark S&P EM Broad Market Index.

Benchmarking the Green Bond Market (FTSE Russell, 2021)

FTSE Russell explores the green bond market, its growth, and the evolving standard in defining green bonds. They examine how green bond indices help to measure performance and enable the development of products to accelerate investment into the green economy.

Benchmarking Has Become Circular (Enterprising Investor, Aug 2021)

The author is not fond of benchmarking, particularly when asset managers follow the recommendations of consultants who use benchmarking to assess a fund's performance. He believes the use of benchmarking creates a ‘herd’ mentality where performance cannot deviate far from an index.

STOXX SRI Indices: Targeting ESG and emissions performers (Qontigo, Aug 2021)

Qontigo outlines the range of STOXX sustainability index-based solutions, focusing on the STOXX SRI investing indices. These indices track the performance of a selection of established benchmarks after screens are applied for carbon emission intensity, compliance, business involvement and ESG performance.

Benchmarking Intensity (CEPR, 2021)

The authors investigate benchmarking intensity (BMI) in stocks, noting that those with higher BMIs tend to have higher prices and lower expected returns. In their view, most active funds simply deviate from benchmarks by a larger degree than passive funds.

Have Hedge Funds Re-Resurrected as Traditional Beta? (2020)

This academic paper examines whether hedge funds are worth the high fees they charge, finding that returns attributable to skill have declined markedly, particularly post-GFC and in North America. In comparison, Asian hedge funds have experienced a smaller decline in alpha, possibly because of their smaller size and impact on markets.

Custom Indexing: Index investing evolves (Investments & Wealth Institute, 2021)

O'Shaughnessy Asset Management explores the theory behind custom indexation and how it might be implemented in portfolios, particularly those with ESG and/or thematic tilts.