Hi, Can someone please help me understand by giving example what these course notes mean ? "This could be the case for a fund that is distributed between various specialist active managers, each of whom has been given a particular benchmark to beat. The aggregate of all of the benchmarks given to the specialist managers may not be exactly the same as the overall benchmark for the fund." "A large fund will have sufficient funds in each asset category to employ a specialist manager for each portion of the fund. The aggregate of all the specialist managers can therefore be made to almost exactly reflect the strategic benchmark for the fund. On the other hand a small fund may not have sufficient funds to employ a UK property manager (for example) and hence may have a difference between its structural benchmark and the aggregate of all the individual portfolio benchmarks." Thanks
Hi, I think I have understood the first point but still unclear of second point The core reading relating to second point course note is The overall risk is the ‘sum’ of the active, strategic and structural risks. For schemes that are not very small, structural risks can be made very small, particularly if ‘peer group’ benchmarking is avoided. Please help me understand this core reading and related course note with the help of an example.
Hi from what I understand: Strategic risk relates to the risk associated with achieving the organization's objectives and plans. In this case, the objective is to track a pre-determined benchmark. Active risk is the risk provided to fund managers, which allows them to take on additional risk with the objective of achieving superior returns, this allows them to purposefully veer away from the benchmark fund to produce greater returns. The additional risk, in this case, would be "mismatching risk". The total asset portfolio of a fund will contain different asset classes. The larger the fund, the higher the fees earned by the fund. This allows them to specialize more in their asset classes by employing more managers. The "structural" benchmark is the pre-determined benchmark that will be used when comparing the performance of our fund. Having large amounts of specialists can help us to track the structural benchmark much more closely and much more accurately. However, the smaller the fund, the fewer managers which decrease the ability to match the structural fund to a high degree of accuracy (since we will have fewer specialists), as a result, there is a higher chance that we will not match the structural benchmark, which generates more structural risk. To address "The overall risk is the ‘sum’ of the active, strategic and structural risks. For schemes that are not very small, structural risks can be made very small, particularly if ‘peer group’ benchmarking is avoided." There are many methods of benchmarking, for example, a hypothetical benchmark could be created which matches the nature of liabilities perfectly, an index could be used that shares a large degree of the characteristics of the liabilities, or performance could be measured by comparing the fund held, to the fund of similar companies. Trying to track/match the funds of similar companies may prove difficult since they have different objectives, goals, risk tolerances etc., and adjusting our fund to match theirs might not be possible due to time constraints, market liquidity risks, and lack of information. In summary, if we use peer group benchmarking, then there are likely to be structural differences between the funds of the different companies, which are difficult to eliminate. If we remove "peer group" benchmarking, the structural risk will decline. Hope this helps
