Portfolio performance: factors or benchmarks?

Abstract

The suitability of using factors or benchmarks to measure portfolio performance is analysed. Fama and French factors are constructed from Russell US stock indexes and then directly utilized as benchmarks. The interpretation of factors as zero-investment benchmarks makes it difficult to explain performance measurement as the comparison of active versus passive management, given the short selling restrictions often applied to mutual funds. Empirical results reveal similar biases in extended Jensen's alphas in models with both factors and with benchmarks and with convexity and nonnegativity restrictions. Selection of the benchmarks has a more important effect than the model type chosen.

Acknowledgements

This study is part of research project P1 1A2004-08 supported by Fundació Caixa Castelló-Bancaixa and project GV04A-708 supported by Generalitat Valenciana. The author would like to express his gratitude to the Frank Russell Company for making the index data available on its website, http://www.russell.com.

Notes

¹ The data indexes and their description, construction and methodology can be found on the Frank Russell Company website, http://www.russell.com (15 December 2004).

² These data are sourced from the Federal Reserve Board on their website at http://www.federalreserve.gov (15 December 2004).