After launching 130/30 index, S&P says best yardstick is actually a long-only index
Apr 29th, 2008 | Filed under: 130/30
Back in November S&P launched its 130/30 Index, a new yardstick for short-extension funds. To create the index they added a short extension to their existing proprietary stock-selection model and chose their words carefully when describing the result…
“The S&P 500 130/30 Strategy Index is designed to measure the performance of an investment strategy that establishes over- and underweight positions relative to the S&P 500, its parent index.”
We were skeptical - noting that 130/30 amounted to simply leveraging the alpha potential of a strategy and was not really a strategy on its own (see posting). But we didn’t confine our skepticism to S&P. We also raised questions about the approach taken by Credit Suisse (see posting). We reasoned that since both indices were based on proprietary models, their performance was entirely contingent on the performance of each company’s underlying investment decisions.
While S&P stopped short of saying its index was “representative” of 130/30 funds, a published index like this is obviously meant to be used as some kind of benchmark for 130/30 managers.
But now another S&P report says the best benchmark for 130/30 managers is actually an appropriate long-only index…
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I would love to see a completely reversed benchmark for all these alpha-oriented strategies. Rather than measuring the funds relative to the market (i.e., the “just don’t do anything”) benchmark, how about measuring the performance relative to how close the manager is from perfect achievement of it’s goals?
For example, you could compare the long portfolio performance vs. the performance of all the stocks in the market that increase, i.e., all the opportunities that were available to make money on the long side. And you could measure the short portfolio performance vs. all the short-able stocks in the market that decreased, i.e., all the opportunities to make money on the short side. And of course measure both over a particular time period.
This way managers would be compared against their investment strategy goal. No manager would be expected to actually achieve this perfect portfolio of longs or perfect portfolio of shorts, but managers would be measured on the basis of relative underperformance against perfection. Kind of like measuring how close they get to the bulls-eye.
I’m oversimplifying here, but you get the idea.
I think there would be a lot more information about manager risk-taking, strategy, and skill contained in this type of analysis than in benchmarking to traditional market indices.