Components of a Portfolio Return? Difference between Benchmarks & Indexes?

[tyler4040]

I’m a little stuck on parsing the return of the market from the style. Intuitively, I imagine a fund manager who focuses on deep value stocks and wants to customize a benchmark based on the S&P 500. Suppose, he modifies the index to only include companies that have a P/B value under 1.0 and a P/E under 15. He locates 100 stocks that fit this criteria and these stocks become his benchmark. He buys 10 of the 100 stocks. Assume that rebalancing the benchmark and portfolio are irrelevant. The Returns are as follows: S&P 500 14%, Benchmark (100 value stocks in the S&P 500) 13%, and the portfolio of 10 stocks 18%. Portfolio Return=Market Return+Style+Active Management (P=M+S+A). This gives the following components: M= 14%, S= -1%, A= 5%.
Am I thinking about this correctly? Particularly when it comes to modifying benchmarks off of indexes?

 

[janakisri]

S&P 500 is not a value index. It is more like a broad market index ( M in the formula ). The manager who chooses to adopt a value style would choose a value index ( e.g. Russell 1000 Value ). The excess return of the Russell 1000 Large Value over the S&P 500 return would be the S term which is reaally the benchmark most closely followed by the manager. Since he is a deep value manager presumably he is trying to do better than the Russell 1000 Value by using his strategy. Any excess return over the Russell 1000 Value index would be the A term.
We might say that the investor has the obvious choice of the broad market proxied by the S&P 500 , while the other two are misfit returns.

 

[tyler4040]

janakisri wrote:
S&P 500 is not a value index. It is more like a broad market index ( M in the formula ). The manager who chooses to adopt a value style would choose a value index ( e.g. Russell 1000 Value ). The excess return of the Russell 1000 Large Value over the S&P 500 return would be the S term which is reaally the benchmark most closely followed by the manager. Since he is a deep value manager presumably he is trying to do better than the Russell 1000 Value by using his strategy. Any excess return over the Russell 1000 Value index would be the A term.
We might say that the investor has the obvious choice of the broad market proxied by the S&P 500 , while the other two are misfit returns.

Thank you!

 

[harryy02]

i think YOU ARE ALSO RIGHT BY YOUR INTERPRETATIONS. YOU ARE ONLY MAKING USE OF A CUSTOM SECURITY-BASED BENCHMARK AS YOUR(manager) benchmark(normal portfolio). so u are actually correct my friend.