Risky business

Some 43% of the respondents to this month's Off The Record survey had investments that were not benchmarked. Of those respondents that did, it is no surprise that illiquid and non-listed assets dominated - real estate, infrastructure and private equity - along with some absolute return and cash mandates.

Over three-quarters of respondents continue to use only market capitalisation-weighted benchmarks for their long-only equity and bond portfolios. However, of those 45 respondents, 27 recognised the weaknesses of market-cap. Only nine thought that market cap-weighted indices were the most suitable for benchmarking.

Eight respondents are currently exploring alternatively-weighted benchmarks. "[We are] looking at different approaches and may decide on population-weighted, GDP-weighted or others," said a Danish fund. A Dutch fund stated: "We are currently analysing sovereign bonds and the use of GDP-weighted indices (or combinations of GDP with other characteristics)."

However, another Dutch fund commented: "We think alternatives are often active mandates disguised as ‘passive mandates' on an ‘alternative benchmark'."

Eleven respondents (almost 20%) are actually using non-market cap-weighted benchmarks at the moment. Interestingly, while most of the non-users who are considering alternatively-weighted benchmarks are focusing on their bond portfolios - one Dutch scheme observed that cap-weighted was "fine" for equities as it rewards successful companies, but "less perfect" for bonds as it rewards the most indebted issuers - those currently using alternative indices were perfectly split as to whether market-cap was more problematic for bond or equity portfolios.

Three funds used alternatively-weighted indices for their entire bonds portfolio, while five did so for part of the portfolio. "We have several bond portfolios, managed by different internal and external managers, with different benchmarks," said a Swiss fund. A Dutch fund added: "Some bond sub-portfolios target a specific investment need that cannot be captured by a common benchmark."

Three respondents used fundamentally-weighted benchmarks for their bonds; and three used other methodologies, including a Dutch fund using "different sectoral weights from a cap-weighted global aggregate benchmark".

Two funds used alternatively-weighted indices for their entire equities portfolio, while five did so for part of the portfolio. Minimum volatility/variance is the most popular approach, use by three respondents; equal-weighted, equal risk-weighted, diversification-weighted, and fundamentally-weighted indices are being used by one respondent each.

Four respondents used asset managers to construct their benchmarks, three used specialist index providers, one used a consultant, and five used other sources - mostly constructing the benchmarks in-house. "We use publicly available index vendors (e.g. MSCI, iBoxx), as well as having in-house built indices," said a Latvian fund. A Dutch fund stated: "We use a maximum diversification benchmark on top of a market cap-weighted one for our equity portfolio."

One Dutch fund implemented its alternative sector-weighted bond benchmarks "right after the credit crisis", but the majority of respondents have only used alternatively-weighted benchmarks since 2010.

Respondents were prompted to use alternatively-weighted benchmarks by a variety of factors. A UK fund highlighted "frustration with index-relative mandates and so-called attribution analysis", while a Czech Republic-based fund trusted its "asset manager's recommendation". A Latvian fund was looking for "better diversification of the portfolio".

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