Investing
Active Funds Are Judged Against A Chosen Benchmark
A fund's stated comparison index is selected by the manager, and the choice determines what counts as outperformance without changing anything the fund actually holds.
Reported performance is almost always presented relative to an index. That index is a choice, and the choice has as much bearing on the reported result as the investment decisions do.
The benchmark defines the question being answered
Saying a fund beat its benchmark means it did better than a specific rule-based portfolio over a specific period. It says nothing without knowing which rule.
Two funds holding similar assets can report opposite outcomes if they compare themselves with different indices, because they are answering different questions with the same portfolio.
This is why the benchmark is disclosed alongside the performance, and why reading the performance without the benchmark conveys very little.
Mismatched benchmarks flatter or penalise unfairly
A fund investing in smaller companies compared against a broad market index will look strong or weak depending on which part of the market performed, regardless of skill.
Similar mismatches occur on geography, sector concentration and currency, where the comparison portfolio has a materially different exposure from the fund itself.
The effect is not always deliberate. Benchmarks are often chosen at launch and retained, while the fund's approach evolves away from what the index represents.
Cash and income treatment change the comparison
Indices are usually quoted either with dividends excluded or reinvested, and the difference between the two versions is substantial over any long period.
Comparing a fund's total return, which includes income, against a price-only index systematically overstates the fund's performance without any misstatement of the figures.
Index returns also ignore the costs of running a portfolio, so a fund matching its index gross of fees will trail it net, which is the ordinary case rather than the exception.
Period selection is a second lever
Performance depends heavily on start and end dates, and a fund can appear strong over one window and weak over another without any change in approach.
Standardised reporting periods exist to limit this, but the choice of which periods to emphasise in marketing material remains available.
Rolling periods, which show performance across many overlapping windows, reveal consistency in a way that a small number of fixed periods cannot.
Tracking closely while charging actively is the hidden case
A fund that holds a portfolio very similar to its index will produce returns very similar to it, minus a fee set for active management.
The measure that exposes this is the degree to which holdings differ from the index, which is disclosed in some markets and inferable from published holdings in others.
Disclosure requirements around this vary by jurisdiction and change over time, so what is readily available to an investor depends on where the fund is sold.
Questions readers ask
Does this mean I should sell before a fall?
Only if you can identify falls in advance, which the evidence suggests almost nobody does consistently. The practical response is choosing an allocation whose falls you can sit through.
Why do average returns overstate what I got?
Because averaging percentages ignores that each return applies to a different balance. The compound return accounts for that and is always lower when returns vary.
