Types of benchmarks

[myriam2222]

Can someone please explain me the difference between a multifactor-model-based benchmark and a returns-based benchmark?
It’s probably not the same thing at all but I don’t get it. Thanks!

 

[daharmattan1]

It’s in the weeds, but here’s my take:
MULTIFACTOR
Think of this as a much broader linear regression model that uses variables like company size, financial metrics, and market timing variables. It involves:

• Identifying the relevant factors—everything from economic variables to fundamental variables like company size, financial metrics, to market timing variables
• Figuring out the exposures of the portfolio and benchmark to those relevant factors
• Specifying a benchmark, whether customized or from a set of normal factor exposures that are typical for portfolio
• Determine the active exposure to each factor and evaluate manager performance

Returns based
Think of this as a regression analysis of the portfoio returns against indices of specific asset-classes. Where each coefficient represents the % of returns attributable to that type of style, i.e. if the co-efficient for large-cap growth stocks = 20%, then 20% of the portfolio’s returns are attributable to that.

 

[myriam2222]

Ok I see. These are two totally different types of input variables in the two different models. It makes total sense. Thanks!

 

[sunseeker]

May I add that while the return-based benchmak can be considered as a valid one because it fulfills out all the basic characteristics i.e.
Investable, measurable, unambiguous, owned, known in advance, appropriate, reflective of current investment opinion, the Multifactor based
model is usually not considered as valid because it’s either ambigous (given all the variables used) and/or not investable.
Finally the curriculum mentions three valid types of benchmarks :
-> Broad market indexes;
-> Returns-based ;
-> Custom-security based (most expensive)
Agreed?

 

[nechets]

if i’m not mistaken, the returns-based takes into consideration the manager’s past return of a set of assset or so…
Multifacto can contemplate variables such as valuation (p/e; p/bv), capitalization, etc…