Selecting and monitoring fund investments is an arduous task, with no guarantee of success. For the majority of funds, the investment and due diligence process includes an evaluation of past performance and risk exposures relative to some benchmark. Thus, the choice of benchmark is critical in this context. However, identifying the relevant benchmark for active managers, who purposefully deviate from benchmarks in the hope of generating alpha, is rarely straightforward. The managers themselves have the most intimate knowledge of their strategy; however, utilizing the manager’s stated benchmark for fund analysis, which is the most common approach taken by investors and practitioners, is not a guarantee for accurate results. This paper develops the concept of “GAP” analysis— an easy-to-calculate measure for identifying the presence and extent of sub-optimality of the investment manager’s stated benchmark.

Mind the Gap: Questioning the Investment Manager’s Stated Benchmark