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Rekenthaler Report

Do Benchmarks Distort the Markets?

A grand unified theory for bad market behavior.

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Big Thoughts
Many believe that using index benchmarks to score, measure, and govern fund managers is harmful for fund performance. The process of comparing a fund's holdings and total returns with those of an index, the critics state, constricts the manager's investment freedom. If a portfolio differs significantly from the index, its manager is questioned as to why. Should that difference hurt rather than help the fund's returns, those queries become second guesses. Eventually, the manager faces the very real danger of being fired.

Two London-based authors have taken the common idea that benchmarks hamper fund managers one very large step further. In Curse of the Benchmarks, Dimitry Vayanos and Paul Woolley argue that using market-capitalization-weighted benchmarks damages more than just fund managers. The practice, they claim, hurts the financial markets themselves. It leads to mispricing, which creates "the misallocation of capital at the micro level, and crises and contractions in the macro-economy." Hampering fund managers in such a fashion is "wealth destroying."

John Rekenthaler does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.