Beware of Benchmarking Games

According to Jason Zweig’s “Intelligent Investor” column in the December 20-21 weekend Wall Street Journal, many mutual funds choose benchmarks which do not closely match the fund’s underlying stock composition which makes it easier to report performance which exceeds their ‘target market’. Zweig cites a study done by financial scholar Berk Sensoy which shows that 31% of US stock funds compare their performance to a benchmark that doesn’t closely reflect what the fund actually owns.

Zweig suggests watching closely to catch if your funds have changed their benchmark for comparison in 2008. Large cap stocks (defined by the S&P 500) have performed worse than small cap stocks in the past few years, so many funds benchmarked themselves to the S&P 500 to show outperformance. Last year, small cap stocks are down as much or more than large caps, so keep an eye out for a change of benchmark to a smaller cap benchmark to attempt to show better relative performance.

Just another of the games that active managers play to keep investing complicated and justify their substantial fees.