Strategic Assets allocation Vs Custom Benchmark

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Azan Khan

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This might be a stupid question…but this is making me confuse…..so please bear with me and try to give some insights about this.
In Assets allocation we select our composition of Assets for our portfolio. then we form our portfolio on the basis of IPS & SAA. For evaluation of portfolio performance purposes we select a benchmark. Right?
Now the Question arrises when we are selecting a benchmark we consider 4 risk factors (Market value risk, Income risk, Credit Risk and liability Framework Risk) that mataches with our portfolio risk factors. So which thing we are evaluating our portfolio or Benchmark? if we are evaluating our portfolio performance to check portfolio manager performance (alpha), how can be portfolio performance can be different than custom benchmark we are forming for evevaluation?
kindly help me, becuase it is very difficult for me to digest this concept.
Magician2000 is requested to explain …please
 
you have a portfolio built up with your various assets.
Assets have some returns that you can see. To invest in those assets - you incur fees (you being the portfolio manager).
How do you now compare what has happened after you invested in your portfolio? You need to compare it against some standard - this is your custom benchmark.
your benchmark needs to be investable - but the benchmark is a paper portfolio. It does not incur any transaction fees. but your actual portfolio does incur fees - management fees + investment fees - to maintain. So your actual portfolio will underperform the benchmark after fees.
Now the other components - which are present in your portfolio (actual one) are:
  • 1. What was the actual performance of the portfolio -> Performance measurement
  • 2. Why did the account perform as it did -> performance attribution -> attribute performance to various sources of return and the importance of those sources in the return.
  • 3. Is this performance due to luck or skill of investment manager -> performance appraisal - and this allows you to compare different managers as well.
 
awsome…Thanks Alot..it makes most of the points cleared…but still i have a question ….Either we select Banchmark on the basis of our portfolio characteristics or we select Portfolio on the basis of Bench mark characteristics because benchmark was matching our return and risk objectives.
if earlier one is true then how we form our benchmark..
let me explain what making me confuse…
for Example;
i have porfolio with following securities A,B,C,D (equally weighted, from diversified industries) With
6%, 8%,10% and 12% per annum return respectively and with same layers of Risk. (Higher risk for Higher Return)
so will we select Same securities(A„B,C,D,) with SAME weights for AND OTHER RISK FACTORS for our benchmark?
OR
securities E,F,G,H from INDEX e.g S&P500 (matching with same characteristics of instruments A,B,C,D respectively).to form benchmark.?
secur
 
We select the Benchmark based on the portfolio characteristic.. As CP said, there can be -
1. Custom benchmarks - Very expensive.
2. Mkt benchmarks which are already available.
The tracking error against custom benchmarks would be lower and against available mkt benchmarks would be much more.
 
it is something you would learn in the later chapter on Portfolio Evaluation.
 
Thanks again for every one.
Evaluation will come latter, but what happen if some one don’t know how to form Standard? the Benchmark.
PLS CPK123
plEASE CORRECT ME..
Steps:
1) First i form a portfolio on the basis of SAA
2) then i Select Securities from an Index e.g. S&P 500 to form a benchmark…the conditions are the selected securities must match characteristics(e.g. Duration, PVD, key Rate Duration, Spread Duration etc.) of portfolio’s securities……Right?
3) then evaluate the performance’s of Portolio & Benchmark with the help of Total Return Analysis and compare them to check either portfolio performed as per standard (benchmark) or below this?
so this means we select “PORTFOLIO ALIKE” securities for BENCHMARK from an INDEX?
plz do answer…
 
Do not forget the purpose of having a Benchmark. You want to make sure that your portfolio is meeting some “standard return requirement”, and also you need a way to be able to confirm your portfolio’s performance. Additionally also remember that a manager’s performance is evaluated against his / her ability to meet some basic performance related to the benchmark. (beat the benchmark(.
Furthermore - never lose sight of the fact that using a bad benchmark and beating it is not a relevent measurement if the benchmark is not the right one.
In order for the benchmark to be a right one - it should meet “SAMURAI” - you will hear this a lot later.
So read up SAMURAI - and what it stands for.
 
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