Performance Measurement in Finance

Chapter 5

Performance benchmarks for institutional

investors: measuring, monitoring and

modifying investment behaviour

DAVID BLAKE AND ALLAN TIMMERMANN

ABSTRACT

The two main types of benchmarks used in the UK are external asset-

class benchmarks and peer-group benchmarks. Peer-group tracking

is much more prevalent with pension funds and mutual funds than with

life funds. However, the use of customized benchmarks that reflect the

specific objectives set by particular funds is increasing. Benchmarks

influence the type of assets selected and, equally significantly, the

type of assets avoided. Peer-group benchmarks have a tendency to

distort behaviour, particularly when combined with a fee structure that

does not promote genuine active management. The outcome tends

to be herding and closet index matching.

The main alternatives to peer-group benchmarks are: single-index

benchmarks with time-varying coefficients, multiple-index bench-

marks and fixed benchmarks. The first two alternatives have recently

been discussed in the academic literature but have yet to catch on in

the practitioner community.

There are also benchmarks based on liabilities. These are generally

related to real earnings or consumption growth or to the discount rate

on liabilities. Explicit liability-based benchmarking is currently not very

common, but is likely to become so in the light of both the increasing

maturity of pension funds, various regulatory and financial reporting

developments, and the Myners Review of Institutional Investment.

Liability-driven performance attribution explicitly takes the liabilities

into account.