In our article “How to evaluate the performance of an investment fund?” we have seen that this performance is usually compared to an index which reflects the overall development of the market in which the fund invests. This index is the fund’s “benchmark”.
If the index increases for example by 5% over a certain period and the value of the fund assets increased by only 2% over the same period, the fund has achieved an “underperformance” in comparison to the overall market. However, if the value of the fund’s assets rises by 7% over this period, the fund has achieved an “outperformance”, it has managed to “beat the market”.
Beating the market is, of course, the goal of every ambitious fund manager, not only on sporting grounds. Although a good performance in the past is no guarantee that a Fund will continue to generate profits in the future, the performance remains the main criteria for many investors when choosing an investment fund. A good performance is thus a fund’s best marketing argument.
In our post about how funds invest, we have already seen that it is very difficult for a manager to consistently be invested in shares whose prices rise more strongly than the market average, but this is a prerequisite for beating the market. At worst, he is predominantly invested in shares whose prices rise less than the market average or even fall. The result is a performance that is significantly lower than the stock market index that the fund compares with – a nightmare for any manager.
To avoid this risk, some managers have opted for a relatively simple solution: They replicate their benchmark.