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Navigating the Pitfalls of Benchmarks: How to Manage Risk in Clients’ Portfolios

Benchmarks are commonly used to measure returns for our clients, but we often overlook the associated risks.

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Dr Michael Streatfield

Dr Michael Streatfield


A diversified multi-asset portfolio is an effective way to manage investment and market risks. Funds use a portfolio benchmark to establish expectations and provide a ‘neutral’ position for taking investment risk. However, this decision is not entirely without risk, as we will explore below.


Risk the client need is still not met

The biggest risk for advisers is perhaps that benchmarks do not promise an outcome.


Strategic benchmarks as a weighted average of asset classes are constructed to enable client outcomes but are based on a longer-term view over at least 5 years. So they hope to steer the portfolio over this time frame.


CPI+ benchmarks are smooth in the short term compared to the volatility in markets. This can make them unhelpful for short-term comparisons and are only better benchmarks over longer time horizons. 


Peer benchmarks give a current pulse of the market but promise no outcome and can be dominated by herding of investment managers.

It is important to consider that clients find no comfort in a situation where a manager outperforms the benchmark over one, three, and five years, but the overall return is negative. We have seen the contribution of SA equity fall over time. However, the ASISA statistics in June 2023 show that high equity multi-asset funds hold the majority share (68%) of total assets under management (AUM) across Low, Medium, and High Equity allocation funds. This means that allocators and managers heavily rely on allocating most assets to a single volatile asset class, which can make the portfolio more risky (making the portfolio more like a one-engine plane).


To manage this risk, it is crucial to understand your client’s time frame and how your asset manager handles risk related to the benchmark. Consider whether your manager maintains a fixed allocation between underlying managers and assets. Are they willing to reduce equity weights to manage drawdown risk regardless of peer positioning? Have they experienced the ups and downs of investment cycles? Understanding these factors can help in managing the risk associated with benchmark performance.


Risk the benchmark influences portfolio construction

There is a risk that the benchmark dictates the portfolio construction. For example, if a portfolio benchmark does not include any allocation to credit, it may imply that only government bonds should be held. This can lead to a situation where the benchmark indirectly influences the portfolio holdings.


To assess this construction risk, it is important to understand the extent to which the manager strictly follows the benchmark or treats it as a rough guide. Managers who take “off benchmark” bets, such as buying a modest portion of credit when appropriate, demonstrate a more flexible approach. Advisers should observe the asset manager’s behaviour, their risk management practices (including tracking error), and changes in asset allocation in the factsheets to evaluate this risk. Funds with rigid allocations may not be agile enough to adapt quickly enough to meet your clients’ needs.


Additionally, slow-moving legislation can impose constraints on asset weights, such as restrictions on offshore equity holdings and minimum cash requirements for certain mandates like the Medical Schemes Act. Benchmarks should reflect these constraints to ensure a fair comparison. For instance, comparing a peer benchmark against all types of funds rather than just medical aid fund peers would be an unfair assessment.


Risk the benchmarks introduce concentration risk

Market-cap weighted benchmarks, such as the S&P 500 or the JSE ALSI, weight a stock’s return by the size of the company (price times number of shares outstanding). This makes a stock more influential as it becomes a bigger weight in the index. This effect has been evident in a few mega-cap stocks that have experienced significant price run-ups, particularly those involved in the Generative AI industry.

Tech and consumer discretionary heavyweights have been driving the US market for some time, using Big Data, Cloud Computing, and AI to revolutionise our lives. shows how the seven US stocks driving the S&P 500 US Equity index level are dominating the market The other 493 stocks, although they doubled in value, have not grown much in comparison. This concentration puts more of the index into a smaller basket of stocks, leading to limited diversification. Although this may be beneficial when markets are rising, it can result in significant losses, as seen in the (painfully) big fall from 1600 to 1000 levels in 2021 and 2022.

So, a change significantly  internally as the market cap composition changes. In SA, have observed shifts over time in resources and Chinese tech, as outlined in this article. We have also seen this with Naspers, Billiton, Prosus and Richemont influencing recent significant weight changes to the index. This means that corporate actions can alter the portfolio overnight, leading to uncertainty in the market.


Implications for investors

Benchmarks, whether peer, CPI, or strategic market-based, serve as different measures to evaluate performance. While they can provide context for investment manager fund performance, they may fall short if not assessed over the appropriate time frame or fail to consider the client’s desired outcome.


For advisers with funds using strategic market-based indices, it is important to stay updated on potential opportunities and understand the asset manager’s track record and ability to exceed the benchmark for outperformance, especially in a period of declining SA equity returns.


For those with CPI+ benchmarks, it is essential to recognise that inflation moves at a different pace than volatile markets. During market turbulence, it is important not to panic and expect significant deviations of funds from benchmarks over short periods. Instead, focus on the longer term while monitoring drawdown risks.


For those with peer benchmarks, be cautious of herding risks, particularly when there is strong consensus. Inflection points can catch investors off guard during these times. If your manager’s performance significantly differs from peers, it is crucial to first understand their risk management approach before questioning their returns. They may be avoiding potential pitfalls that others are facing.

Remember to consider the risks associated with benchmarks, not just the returns they offer.

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