Well, really the benchmark of ANY strategy is its opportunity set but I thought I would use the 130/30 funds as an example. I have written before about what 130/30 funds are, and how the appropriate benchmark for such a strategy would be the plain vanilla market-cap weighted underlying index.
What Is A 130/30 Strategy?
As an example, Thicken My Wallet recently wrote about HAH which is an ETF that runs a 130/30 strategy on the S&P/TSX 60 index. The manager will buy (or replicate) the S&P/TSX 60 index and then reduce the exposure of the 10 “worst” stocks by 3% each (=30%). If any of those particular stocks have a weighting of less than 3% in the S&P/TSX 60 index then the fund will short sell in order to achieve this net -3% relative exposure. The 30% of the fund’s assets that are freed up are then deployed across the 10 “best” stocks in the S&P/TSX 60 index and their long exposures are increased by 3% each (=30%).
What Is The Best Benchmark For A 130/30 Strategy?
Horizons Alpha Pro, which is the provider of HAH, indicates that the benchmark is the S&P/TSX 60 130/30 Strategy Index, provided by Standard & Poor’s, but I would argue that the S&P/TSX 60 130/30 Strategy Index is only useful in monitoring tracking error of the actual fund. The best benchmark would be the S&P/TSX 60 Index itself.
If you look at any large cap Canadian equity manager, who is holding different weightings of stocks versus the index, they are measured against the plain vanilla index. So why should any other active strategy be treated differently? How else are you going to gauge if the strategy is working or not? The divergence in returns between HAH and the S&P/TSX 60 130/30 Strategy Index will tell you about the fund management’s execution, but the divergence in returns between HAH and the S&P/TSX 60 index will tell you whether the strategy is working or not. They are two different things.
What Do You Mean By Opportunity Set?
The opportunity set just refers to all the investment options available to the fund or manager. A Canadian equity fund, in theory, should only be picking from Canadian stocks and that is the opportunity set. The indices are proxies for the Canadian marketplace and are essentially used interchangeably as the defined opportunity sets (which I might add is sloppy, since there are thousands of stocks listed in Canada but that’s a rant for another day…) :)