If the active manager is successful, tracking error is positive and the portfolio outperforms the benchmark if not, the portfolio underperforms its benchmark.Īn investment portfolio, whether actively or passively managed, may hold securities different from its benchmark for other reasons. When a portfolio is actively managed, tracking error may reflect the investment choices made by the active manager in an attempt to improve performance. Typically reported as a standard deviation percentage, tracking error may be positive as well as negative. The difference between the performance, or investment return, of an individual portfolio and its benchmark is known as tracking error. How are benchmarks used to track performance? GLADI attempts to identify investment opportunities in fast-growing economies and also includes more instruments than a general broad-based bond market index, such as swaps and inflation-linked bonds. In part to avoid overexposure to highly indebted countries and companies, in 2009 PIMCO introduced the PIMCO Global Advantage Bond Index (GLADI), a bond index based on gross domestic product rather than market capitalization. Among these, fundamental indexing, developed by PIMCO subadviser Research Affiliates, selects and weights companies using fundamentals such as sales, cash flow, book value and dividends.īond indexes using market-cap weighting can have a troubling twist: The most influential, or largest, components may also have the biggest debt loads, which can be a sign of deteriorating finances. To reduce the volatility that may result with market-cap weighting and potentially improve performance, alternative indexing methodologies have emerged in recent years. As a result, big price swings in the stocks or bonds of the largest companies can create big price movements in an index. Companies with more equity or debt outstanding receive higher weightings and therefore have greater influence on index performance. Instead of averaging stock or bond prices, indexes typically weight each component the most common weighting is based on market capitalization. Index methodologies, returns and other statistics are usually available through the index publisher’s website or through news services such as Bloomberg or Reuters. The major index providers use specific, predetermined criteria, such as size and credit ratings, to determine which securities are included in a particular index. What are the methodologies used to create indexes? Select Real Estate Investment Trust (REIT) Index and the Bloomberg Commodity Index. A couple of examples are the Dow Jones U.S. Indexes also exist for other asset classes, including real estate and commodities, and these may be of particular interest to investors concerned about inflation. Morgan created its Emerging Markets Bond Index in 1992 to provide a benchmark for emerging market portfolios. For example, as investor demand for emerging market debt grew, J.P. New indexes are often created as investor interest grows in different types of portfolios. Aggregate Bond Index, which tracks the largest bond issuers in the U.S., and the Bloomberg Barclays Global Aggregate Bond Index, which tracks the largest bond issuers globally.Īctually, bond firms have created dozens of indexes, providing a benchmark for virtually any bond market exposure an investor might want. Widely known indexes include the Bloomberg Barclays U.S. As a result, the most commonly used indexes are those created by large broker-dealers that buy and sell bonds, including Bloomberg Barclays Capital (which now also manages the indexes originally created by Lehman Brothers), Citigroup, J.P. Because stocks trade on open exchanges and prices are public, the major indexes are maintained by publishing companies like Dow Jones and the Financial Times, or the stock exchanges.įixed income securities do not trade on open exchanges, and bond prices are therefore less transparent. Numerous other equity indexes have been designed to track the performance of various market sectors and segments. Using an index, it is possible to see how much value an active manager adds and from where, or through what investments, that value comes. Indexes represent a “passive” investment approach and can provide a good benchmark against which to compare the performance of a portfolio that is actively managed. Because indexes are unmanaged, they track returns on a buy-and-hold basis and no trades are made to reallocate to securities that may be more attractive over different market cycles or market events. An index tracks the performance of a broad asset class, such as all listed stocks, or a narrower slice of the market, such as technology company stocks. In most cases, investors choose a market index, or combination of indexes, to serve as the portfolio benchmark.
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