Albert Louw
Head of Business Development,
STANLIB Multi-Manager
The perils
of a CPI benchmark
By Albert Louw, Head of Business Development, STANLIB Multi-Manager
A discussion of the pitfalls of using one benchmark in particular, CPI (the consumer price index), with regard to performance evaluation.
Evaluating the performance of an asset manager is often subjective. Broadly speaking, there are three
elements to consider:
- Measurement – choosing an appropriate benchmark
- Attribution – determining which asset classes or instruments contribute to relative performance
- Appraisal – understanding the meaning of the performance
All come with their own complexities, regardless of how a manager structures their fund. In this article I discuss the pitfalls of using one benchmark in particular, CPI (the consumer price index), with regard to performance evaluation. Instead of addressing how performance evaluation should be done in this context, I will instead focus on the important dimensions to consider.
Why is CPI used as a benchmark?
Despite its limitations, CPI is widely used as a benchmark, and with good reason. In a goal based world, an absolute return (nominal or real) is necessary if you are saving towards a goal, as you need a mechanism to discount your investments and liabilities. CPI plus an additional percentage represents a real return over inflation and makes sense to all sorts of investors. Contrast this with a target of 2% alpha over an index other than CPI, say an equities index. This gives no insight into the relative value of money. The fund could have achieved its objective of say 5% while the index returned 3%. If inflation over the period was 6%. the value of money invested and its purchasing power decreased because it’s eroded by inflation.
What makes a good benchmark?
A benchmark should serve as a point of reference to which other things may be meaningfully compared. A good benchmark is one that is fully consistent with a manager’s investment process, style and philosophy. This consistency makes it easier to evaluate the skill of a manager, and their ability to exploit perceived opportunities by taking “off-benchmark” bets that translate into alpha. An appropriate benchmark serves as a sanity check to ensure a manager follows the style and philosophy they claim to follow.
Benchmarks should communicate information about the manager’s investable universe and provide an indication of acceptable levels of risk versus return. To do this they need to conform to the characteristics of good benchmarks:
- Investable – it should be possible to replicate and hold the benchmark, i.e. the weights and securities in the benchmark should be identifiable and available for investment
- Appropriate – the benchmark should be consistent with investment style and reflective of the manager’s investment opinions
- Accountable – the benchmark chosen signifies the manager accepts ownership of the constituents and is held accountable for significant deviations
