Often when clients listen to advisors and others talk about investments, they will hear the word “benchmark” being used frequently. This article will take a look at what benchmarking is, how it works, and why it is so important.
What is a Benchmark?
For illustration purposes, we are going to look at a benchmark ETF, called iShares REIT ETF, that trades on the NYSE under the symbol REET. Its purpose is to track the global REIT index, and we use it to compare the risk level and performance of the two real estate-focused mandates we use here at CH, namely the CI Global REIT fund and the Dynamic Alternative Yield fund.
The benchmark ETF in this example includes REITs sold on stock exchanges all over the world and it allocates the same percentage of its investments into each REIT based on how large that REIT is. Since the managers do not need to decide if a specific REIT is currently over or undervalued, there is very little management required to run the fund which helps to keep the fee low. As a comparison, the iShares REIT ETF has a Management Expense Ratio (MER) of 0.14% whereas the CI Global REIT fund has an MER of 2.32% and Dynamic Alternative Yield has one of 2.38%. This means the ETF is over 2.2% cheaper than the mutual funds.
How do we compare funds to their benchmark?
Since both ETFs and mutual funds are required to track their level of risk/volatility together with their respective rates of return, it is relatively easy to compare the different investments. So, how do they stack up?
First, let’s look at the rates of return net of all fees charged by each fund:
| Fund/ETF | 1 year Performance | 3 year Performance | 5 year Performance |
| CI Global REIT | 31.67% | 11.44% | 8.58% |
| Dynamic Alternative Yield | 47.24% | 12.37% | 8.98% |
| iShares Global REIT ETF | 33.79% | 7.08% | 4.83% |
As we can see, over rolling 3 and 5-year periods the two mutual funds outperformed the index ETF by roughly 4-5% per year even though both charge a much higher fee.
Next, we can take a look at the level of risk in each fund based on total volatility. Two mathematical measures are commonly used. The first is called standard deviation which measures volatility. The larger the number the higher the level of volatility. The second is known as “beta” and it measures how closely the fund correlates or mimics the performance of the underlying index. If the index and the fund go up and down by the same amount then beta is 1. If there is no correlation at all then the measure would be zero. Furthermore, if a fund went up and down twice as much as the index then the beta would be 2. Typically, lower beta is seen as good since it reflects the fund being less subject to the daily ups and downs of the market.
| Fund/ETF | 3 year Std Deviation | 3 year Beta |
| CI Global REIT | 14.25 | 0.92 |
| Dynamic Alternative Yield | 14.69 | 0.88 |
| iShares Global REIT ETF | 21.03 | 1.00 |
By both measures, our mutual fund teams have been less volatile than the index and its ETF. In the case of standard deviation, this is especially striking with the ETF having almost 50% more volatility!
For CH, higher rates of return with lower volatility will always be our preferred combination.
Conclusion
The purpose of this article was to give you some insight into how we measure the performance and risk levels of each of our funds. In most cases, we can find a comparable index, and often even an ETF that represents that index. We can then judge our managers to see if they are doing better or worse than their given benchmark.
Our work doesn’t end here, of course. As we have noted in other CH Minute articles, we still need to decide on things like a proper asset allocation for each client, monitor how closely our fund managers continue to remain focused on their specific area of expertise, and the stability of the management team itself. Finally, we at CH must constantly be asking ourselves if we think our clients should even be in a particular investment space (such as real estate, government vs. corporate bonds, small-cap, large-cap, emerging markets, etc.). Benchmarking helps us at each stage of this evaluation process.
We hope this article has shed some light on what benchmarks are and how we use them to help our clients achieve their investment goals. As always, we welcome any feedback, and in a future CH Minute, we will take a look at other benchmarking examples.
All the best,
Brian Trafford, Chief Investment Officer
& Your CH Financial Team
403-237-6570