Question: How to follow and beat the benchmark?

Kinda stuck on this general Question and answer report I have to write, the question is too abstract How to follow and beat the benchmark? Any inputs would be greatly appreciated.

Wouldnt it be to match it as much as possible except for slight differences when you believe another stock is a better value than something in the benchmark.

The objective of following a benchmark is to provide the portfolio manager with consistent asset class exposure to maintain the integrity of the desired asset allocation. Following the benchmark means setting specific tracking error targets as specified in the IMA. Tight tracking error would be a 1% target (this is a standard deviation measurement). To tracking the benchmark portfolio the manager can (1) hold a cross-section of the same securities or (2) holding a portfolio of similar securities. Assuming the benchmark comprises a small number of securities, and or is easily replicable option 1 would work best. If the benchmark includes a large number of securities and is not easilty replicated option 2 works best (this is common for fixed income portfolios). To beat the benchmark the manager must assess the alpha opportunities. For equities the process is picking “mispriced” securities based on some analytical tool. Portfolio manager can overweight securities, or even pick securities from outside the benchmark. The trick is to make sure that the out-of-benchmark position pay off in terms of alpha, and understand the correlations between the out-of-benchmark positions relative to the benchmark portfolio. For fixed income the process is similar. The difference in fixed income is that there are more dimension to the risk analytics that should allow for both tighter tracking error targets and more consistent alpha. The easiest way to beat the benchmark in fixed income is to load up on more credit/spread product and “out-yield” the benchmark. Over long period of times, however, the cyclical nature of credit markets will cause material deviations from the benchmark and blow the tracking error budget. Again like equities the manager must find either mispriced securities within the benchmark to overweight (predict future price changes), or find out of benchmark securities that offer improvements to the risk/reward profile of the index.

great stuff, greatly appreciated.

Buy a swap on the bench, say S&P, so you get the S&P return and pay say LIBOR + 50bps, then get an alpha source, ie hedge fund, and hopefully you will get the Benchmark - LIBOR - 50 bps + Libor + HF Alpha = Benchmark - 50 bps + HF alpha. Ok I may have cheated as that may be pushing it as that is way too complicated and not viable for a simple Long only strategy :). You can always but some index tracking funds, ishares, spidrs, etc, and then purchase a basket of securities that you expect to outperform.

Not the most techical post but… buy the ETF of the index with the majority of the fudn and overweigth the “undervalued” stocks/bonds etc with the remaining. Or you coudl use the remainign to add exposure to issues not in the index.

by a future to an index and invest cash money into money market.

kide Wrote: ------------------------------------------------------- > by a future to an index and invest cash money into > money market. Ditto ^

rkingston, that was really nicely explained.