Alternative Investments: CAIA Level I, 3rd Edition

CHAPTER 7 Benchmarking and Performance Attribution

Alternative investments and alternative investment strategies tend to have nontraditional risk exposures. Alternative investment strategies typically strive to actively achieve superior risk-adjusted returns more so than do most traditional investments and traditional investment strategies. These characteristics make benchmarking and performance attribution of alternative investments especially challenging and important. This chapter begins with an introduction to benchmarking. Throughout the chapter, asset pricing models are emphasized as a broader and deeper way of thinking about benchmarking. Benchmarking and asset pricing models are tools for managing risk, identifying sources of past return, and forecasting potential sources of future return.

7.1 Benchmarking

The starting point for analyzing the risk and return of an investment is often to compare the investment with a benchmark. Benchmarking, often referred to as performance benchmarking, is the process of selecting an investment index, an investment portfolio, or any other source of return as a standard (or benchmark) for comparison during performance analysis. Benchmarking is typically performed by investors and analysts external to an investment pool for the purpose of monitoring performance. Fund managers may be reluctant to adopt or declare a benchmark because they may believe that the performance of their investment strategy cannot be properly linked to a benchmark ...