“To create a returns-based benchmark using Sharpe style analysis, an optimization procedure is used in which the portfolio’s sensitivities (analogous to the bk’s in factor-model-based benchmarks) are forced to be non-negative and sum to 1.”
Institute, CFA. 2017 CFA Level III Volume 3 Economic Analysis and Asset Allocation. CFA Institute, 07/2016. VitalBook file.
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I dont get how is that different from style based benchmark?? There was a post a few years ago but it only explained return based vs holding based analysis…
Style index is a certain category of a broader market index – like Large Cap Growth or Small Cap Value.
Using a formula to calculate the best mix, return-based is a combination of style indexes used to mimic the portfolio returns over a specific period of time.
As I understand that the disadvantage of style-baesd benchmark is as such “Further, the definition of investment style implied in the benchmark may be ambiguous or inconsistent with the investment process of the manager being evaluated.”, may i know why this disadvantage does not surface in the return-based benchmark?
Any manager can choose whatever style benchmark they want, doesn’t mean it’s right. But if you regress your returns against style indices you can’t hide your sources of returns.