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Rekenthaler Report

The Curse of Benchmarks, Part II

Does benchmarking fund managers harm the financial markets?

The Big Idea
Wednesday's column detailed the claim, by Dimitri Vayanos and Paul Woolley, that using market-cap-weighted benchmarks (such as the S&P 500) to track portfolio managers creates distortions in financial markets.

They argue that when a large, volatile security in an index surges in value, investment managers who are underweight in that holding are punished thrice. Not only do their funds' relative performances suffer, as they do not fully participate in a meaningful gain in the index, but those managers face awkward questions about why they missed the opportunity. In addition, because the security now makes up a larger chunk of the index, the funds have become even more underweight. The managers are sorely tempted to rectify matters by buying into the winners.