Relative Comparisons

Evaluating pooled investments requires comparing them against appropriate benchmarks and monitoring changes in management, policy, and style.

Benchmarks

A benchmark is a standard against which fund performance is measured. The appropriate benchmark must match the fund's investment style and asset class.

  • Funds should be compared to an appropriate benchmark index matching their investment style
  • Large-cap U.S. equity fund vs. S&P 500
  • International equity fund vs. MSCI EAFE
  • Bond fund vs. Bloomberg Aggregate Bond Index
  • Benchmark comparison reveals whether the manager adds value (alpha) or underperforms

Exam Tip: Gotchas

Use the right benchmark. Comparing a bond fund to the S&P 500 is inappropriate. The benchmark must match the fund's asset class and investment style.

Manager Tenure

  • Length of time the current portfolio manager has managed the fund
  • Short tenure may mean past performance is not attributable to the current manager
  • Manager changes can signal shifts in investment strategy or approach

Think of it this way: Past performance belongs to the person who generated it. A fund's 10-year track record is irrelevant if the manager who achieved it left two years ago.

Exam Tip: Gotchas

Past performance of a mutual fund may be irrelevant if the portfolio manager recently changed. Always check manager tenure before relying on historical returns.

Change in Investment Policy

  • A fund may change its investment objective or strategy (requires shareholder vote for fundamental changes)
  • Past performance data becomes less relevant after a significant policy change
  • Investors should review the prospectus for any recent changes

Investment Style

  • Morningstar-style boxes classify funds by: size (large/mid/small) and style (value/blend/growth)
  • Style drift - when a manager deviates from the stated investment style
  • Active vs. passive (index) management affects fee levels and expected tracking

Exam Tip: Gotchas

A change in investment policy makes prior performance data unreliable. Similarly, style drift is a red flag: if a fund's holdings no longer match its stated strategy, the adviser should investigate.

Securities Indexes as Benchmarks

  • S&P 500 - 500 large-cap U.S. stocks (market-cap weighted)
  • Dow Jones Industrial Average (DJIA) - 30 blue-chip stocks (price weighted)
  • Nasdaq Composite - all Nasdaq-listed stocks (tech heavy)
  • Russell 2000 - small-cap U.S. stocks
  • Wilshire 5000 - broadest U.S. equity index (total market)

Indexes are unmanaged and do not incur fees; comparing a fund's returns to an index without adjusting for fees is misleading.