Benchmark buyer beware: How well do you know your index?

Paul A Hamilos and Jason M Ribando
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Paul A Hamilos: RS Investments

Journal of Asset Management, 2016, vol. 17, issue 2, No 3, 89-99

Abstract: Abstract While benchmarks are important tools for portfolio managers and investors alike, we challenge the conventional wisdom that they are paradigms of investing excellence. Despite the effective marketing campaigns that have brought benchmarks into the public consciousness and attracted significant capital to passive investment strategies, few investors fully understand how these benchmarks are calculated or what they represent. We dissect the benchmark construction process and reveal how decisions made by index providers can lead to unintended factor exposures in various benchmarks. Using the Russell Midcap® Value Index as our primary example, we find evidence of size, momentum and sector tilts, as well as outsized exposure to interest rates, clientele effects and low-quality businesses. We demonstrate that without full understanding of benchmark construction, evaluations of active-manager performance are unreliable. Moreover, factors that have led to outperformance by index funds in recent years could easily reverse.

Keywords: benchmark construction; active management; passive investing; book-to-price; Russell Midcap Value Index; manager skill (search for similar items in EconPapers)
Date: 2016
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DOI: 10.1057/jam.2015.41

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