PLANSPONSOR - October/November 2021 - 32

PLAN BENCHMARKING | INVESTMENT TYPES
Next Steps in Indexing
And Benchmarking
Returns data illustrate manager performance,
but the amount of risk a portfolio
took to achieve its returns-its riskadjusted
return-is critical information.
Less volatility to achieve a given return
is generally preferred to higher volatility
that produces the same result. A returns
series' standard deviation measures volatility,
but tracking error-also known as
active risk-which measures the returns'
variance around the benchmark's returns,
is also widely used, Thiemann says.
From a plan participant behavioral
perspective, active risk matters because a
high level of active risk leads to increased
trading activity, she says. " So, for us, it's
important to not only look at standard
deviation or the absolute return measure,
but we also want to look at tracking error
and start to understand how different this
investment product's returns are relative to
WORKING WITH ESG FUNDS
B
its benchmark. Is that appropriate for XYZ
plan sponsor's current lineup, the other
funds it offers? How might participants
react, given certain market environments,
depending on that tracking level? "
Upside and downside capture ratios
provide insight into a fund's performance
compared with a benchmark in rising-
i.e., upside-or declining-i.e., downside-markets.
Morningstar calculates the
ratios using monthly returns for multiple
historical evaluation periods. According
enchmarking environmental, social and governance (ESG) funds poses unique
challenges. The first is the broad span of sustainable-investing strategies that
comprise " ESG " -e.g., a fund seeking to invest in companies that reduce greenhouse
gases is not directly comparable to a fund with governance goals.
A presentation at The Wharton School's virtual conference " ESG Confusion
and Stock Returns: Tackling the Problem of Noise, " in April, illustrated the wide
variation in ratings of international companies by ESG rating services. The
average correlation of scores from different ESG raters varied from 40% to 70%,
with disagreements over rating measurement methods driving the differences.
Second,
the number of ESG-related indexes keeps growing. The Index
Industry Association (IIA) reports that many newer indexes focus on ESG
themes in both the equity and fixed-income categories.
Per the IIA: " The number of ESG indices globally rose by 40.2% in the
past year following a 13.9% rise from 2018 to 2019, registering the highest
year-on-year increase in any single major index class in the survey's four-year
history. Fixed-income growth has also been steady, with a nearly 15% rise in
the number of indices measuring global bond markets over the past two years,
with notable growth in the ESG sector within fixed income as product issuers
look to build more-diversified and ESG-compliant products. "
A way to reduce the potential confusion is to focus on a specific ESG metric.
Research by Dimensional Fund Advisors (DFA) has found that ESG investment
strategies' greenhouse gas emissions tolerance varies considerably across strategies.
Focusing on the emissions yields of a portfolio's holdings vs. the overall
market is a useful benchmark to DFA, says the firm's Wes Crill, though, he says,
he knows of no other similar index.
Another option: Wait to use ESG-specific benchmarks until there is more
clarity in the definitions and the metrics. Stan Milovancev, executive vice president
at CBIZ Retirement Plan Services in Cleveland, says CBIZ continues to
predominately use the traditional benchmarks. " We're not taking a specificESG-type
benchmark, " he says. " We're taking more of a benchmark of that
core asset class in general. " -EM
to the firm: " All stock funds' upside and
downside capture ratios are calculated
versus the S&P 500, whereas bond and
international funds' ratios are calculated
relative to the Barclays Capital U.S. Aggregate
Bond Index and MSCI EAFE [Morgan
Stanley Capital International Europe
Australasia and Far East] Index, respectively.
For some context, we also show the
category average upside/downside capture
ratios for those same time periods. "
Portfolio fees are another important
benchmarking consideration, and they are
by far the largest component of plan fees
and expenses association with managing
plan investments. The Department of
Labor (DOL) says fees for investment
management and other related services
generally are assessed as a percentage
of assets invested and employers need
to pay attention to these fees. They are
paid in the form of an indirect charge
against the participant's account or the
plan because they are deducted directly
from investment returns. Net total return
is the return after these fees have been
deducted. For this reason, these fees,
which are not specifically identified on
statements of investments, may not be
immediately apparent to employers.
Third-party sources such as the
" 401k Averages Book " provide non-biased,
comparative 401(k) fee information based
on plan size, and aim to supply professionals
with information they need to
gauge whether their plan costs are above
or below average. Thiemann explains that
Willis Towers Watson provides a detailed
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