Risk, Return, and Benchmarking
Alternative investments and alternative-investment strategies tend to have nontraditional risk exposures. Alternative investments and strategies attempt to achieve superior risk-adjusted returns more so than most traditional investments and traditional investment strategies. The starting point for analyzing the risk and return of an investment is often to compare the investment with a benchmark. This chapter begins with an introduction to benchmarking. Throughout the chapter, the focus is on asset pricing models, which are in some respects a broader and deeper way of thinking about benchmarking. An asset pricing model is a framework for specifying the return or price of an asset based on its risk, as well as future cash flows and payoffs. We can use asset pricing models as tools for managing risk and for identifying sources of past return and potential sources of future return. Asset pricing models are not simply mathematical exercises. They are ways of expressing the most fundamental issues related to investing: the nature of the risks and returns of investment opportunities.
Benchmarking, often called performance benchmarking, is the process of selecting an investment index, an investment portfolio, or other source of return as a standard for comparison during performance analysis. Benchmarking, including the process of identifying an appropriate benchmark, is typically performed by investors and analysts external to ...