(March 7, 2012) — Constructing a benchmark away from a market capitalisation-weighted index would help investors’ risk-adjusted returns from passive equity, according to Goldman Sachs Asset Management.
Presenting at the National Association of Pension Funds annual investment conference in Edinburgh this morning, Paul Craven Head of EMEA Institutional Business at GSAM told a group of pension fund investors that usually benchmarking can lead to bad decision-making.
“As a trustee, we set asset managers a benchmark, which is where they start – if we can set them a better benchmark, why not start from there?”
Some 78% of investors in the seminar said they had some form of passive investment; Craven said by altering the benchmark against which they set their equity allocation, they could earn a better return.
The approach set out by GSAM would be to cut out the highest risk beta, or market return, stocks from a range of equities — then weight the remaining stocks according to the intrinsic value of the company, which could be worked out by adding the value of the company assets to its potential for growth. To invest in a range of countries, investors should look at those with the highest growth. “Sometimes factors look different but when put together they combine to make something better,” Craven said.
He quoted figures showing that combining the two factors resulted in a higher return for the GSAM index approach than the market-weighted index – or the two factors used separately. The approach also boasted a better risk-adjusted return.
“Consider what happened in the 1980s – 44% of the MSCI world index was made up of Japanese stocks due to their market cap, despite the GDP being in the teens in terms of value,” Craven said. “The same happened in the early 2000s when IT stocks made up 37% at the peak of the bubble, despite contributing only 5% of revenues. This approach will not give an investor the massive upside of a bubble, but it will protect them from the pain of the crash.”
GSAM is in the final stages of putting together a range of indices with an index provider focussed on this approach.