What is meant by this "benchmark"?

Question

im desperately need help on this. i found this statement on wikipedia but its unclear to me.

Alpha represents the fund's return when the "benchmark's" return is 0. This shows the fund's performance relative to the benchmark and can demonstrate the value added by the fund manager. The higher the 'alpha' the better the manager. Alpha investment strategies tend to favour stock selection methods to achieve growth.

Beta represents an estimate of how much the fund will move if its "benchmark" moves by 1 unit. This shows the fund's sensitivity to changes in the market. Beta investment strategies tend to favour asset allocation models to achieve outperformance.

Anyone help me clear my doubts and full pts shall be awarded. Thank you so much and God Bless =)

Answer 1

Benchmark in this context refers to an index the asset is compared to. For example, BHP Billiton's (trading on the Australian Securities Exchange) "benchmark" would be the S&P ASX 200 - an index of the top 200 Australian companies (by market capitalistaion).



So if BHP Billiton gains 10%, and the ASX gains 5%, it's beta is 2.0.



Most stocks should be compared to the 'all ordinaries' index, unless there is a specific index for it (eg resource stock indexes, finance indexes or leading companies indexes).

Answer 2

A benchmark is something you can measure against. So you might compare your investment in stocks and shares against the FTSE 100 or maybe cash at the bank rate. so if your benchmark is set at 0 and your investment performs 10% better its Alpha might be 0.1

Beta is, I think a factor by how much your investment beats its benchmark. So if your stock moves up (or down) 10% when the benchmark (say FTSE100) moves up (or down) 10% its Beta would be 1 (equal) If, however the portfolio moved 20% agaianst the benchmark's 10% it's Beta would be 2.



There is another figure that measures acceleration of these movements and that also is quite important.



So practically, if you thought the market was going up and you wanted to benefit more than the rise you would buy a high Beta stock. Of course if you get it wrong you lose more!

Answer 3

A benchmark is a standard against which performance can be measured. It is a goal that should be reasonably attainable, so that when performance has been completed and can be measured, it can be compared against the benchmark. Rather than trying to understand the convoluted explanation you have, we can look at a simpler example.



You do a lot of driving and would like to keep the cost of fuel as low as possible. You know your car is rated at an average consumption of 22 miles per gallon. You decide that this is a benchmark. You start keeping track of your fuel purchases and miles driven over a period of 60 days. Now you calculate your average fuel consumption and you find that it is 19.2 mpg. Either your benchmark is too high, i.e. unattainable, or your performance is poor. You change your driving habits: You accelerate slowly, avoid high speed driving, avoid stop and go driving and rush hours. After another 60 days you again measure your fuel consumption and you find that it is 21.7 mpg. You are very close to your benchmark. Or you get 23.2 mpg. You exceeded your benchmark. You are happy. You jump for joy. Or you set a new benchmark of 24 mpg and see if you can reach it in the next 60 days.