Tuesday, July 10, 2007

Understanding Funds Benchmarking

Each time you are considering investing in an investment fund you should carefully go through past performance reports, as well as other resources such as investment strategy, top holdings, market outlook, in order make an informed decision. While you are doing so, you will often see performance comparisons with a Fund’s benchmark.

Benchmark is a standard by which something is evaluated or measured and, in the case of investment funds, it is an economic index by which the performance of the investment fund is evaluated. In simple words: if the fund outperforms the benchmark, it did well. If the fund underperforms the benchmark, it did not do well.

It is important to have benchmarks to keep the performance analysis less intuitive and more technical. A stock’s fund that has a 15% year return in the U.S. may be seen as good fund while the same performance in emerging countries may not be good. This happens because S&P 500 had a 13.6% high in 2006, while Brazilian stock exchange (IBovespa) had a high of 48.4%.
When I compared the fund performance with the respective stock index I used the index as the fund’s benchmark.

The image above is an example of Fund performance report. The red bar is the fund's actual performance in 2006, the middle grey bar is Benchmark 1's performance in 2006 and the right dark grey bar is Benchmark 2's performance in 2006. As you can see, the fund in question overperformed Benchmark 2 but underperformed Benchmark 1.

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