
ifabt.com - When analyzing your investments, proper benchmarking is the most critical factor in determining whether active managers possess the skill necessary to consistently deliver returns in excess of the risk-appropriate benchmarks. http Proper Benchmarking and Alpha Sept 09, 2010 By: Mary Brunson When you look at your own personal investments, or those of an foundation, 401(k) or defined benefit pension plan, proper benchmarking is the most critical factor in determining whether active managers possess the skill necessary to consistently deliver returns in excess of the risk-appropriate benchmarks. A Little Background In 1952, Nobel Prize winner and consultant to Index Funds Advisors, Harry Markowitz set forth his Nobel Prize winning notion that risk must be considered as well as return. Through his risk-reward scatter plot (LINK), you can estimate whether or not your investments have been optimized so that your expected returns are maximized for your current level of risk. In 1964, Sharpe's Capital Asset Pricing Model set forth the idea that the returns of investments are explained by how closely those investments have matched or correlated to the market portfolio. The market portfolio is considered a "beta" of one and investments with betas greater than one (more volatile) should have higher expected returns and visa versa. This single risk factor model is a common measure obtained from Morningstar or Lipper data, however, it only explains about 70% of the returns <b>...</b>
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