“Opening the Black Box” is our ongoing series on the data treatments, assumptions, and methodologies behind our analyses. In this series, we answer frequently asked questions on how we build, validate, and make decisions about our data.
Thoughts or feedback for us? We welcome it.
So far, this series has covered how CEM governs its data and how that data moves from collection through delivery. With that foundation in place, we turn to a question our subscribers often ask once they receive their results: how does CEM build the comparisons?
We start with investments, and with the most basic question of all: what exactly is being compared to what?
No two investment programs look alike. Some plans split equities into domestic versus foreign. Others organize around beta tracking versus alpha seeking, or large cap versus small cap. Every structure reflects a plan’s own strategy and history, and that is exactly as it should be.
This creates a challenge for benchmarking. Peer-to-peer comparability is only possible when portfolios are standardized. We invest heavily in making the comparisons apples-to-apples, and in the rare cases this is not possible, being transparent with you.
How does CEM structure the comparison?
At CEM, investment comparisons span seven asset classes: Public Equity (i.e., stock), Fixed Income (i.e., bonds), Multi-Asset Strategies, Real Assets, Private Equity, Private Credit, and Derivatives (i.e., overlays).
Each asset class is broken down further into a total of 76 sub-asset classes (e.g., US small-cap equity, high-yield bonds, REITs, commodities, private mortgages) and nine different implementation strategies (e.g., internal management, fund of funds, co-investments).
We construct cost benchmarks for each implementation strategy within every sub-asset class. Your internally managed passive US large-cap equity is benchmarked against peers’ internally managed passive US large-cap equity. Your externally managed core real estate is benchmarked against peers’ similar assets. This is what makes the comparison insightful and actionable.
The complete list of all the sub-asset classes and implementation styles we benchmark is available on our survey portal.
How our data principles apply
Granularity is only useful when enough data backs it. Every asset class level cost and performance comparison must meet a minimum count of data points in the comparator group, whether that is a peer group or a broader universe, to be statistically meaningful.
We recognize that our standardized list of sub-asset classes and strategies will never be exhaustive. Markets evolve, and so do the ways plans invest. Our approach is to limit benchmarking to sub-asset classes where reasonable counts are reported. Once we see multiple plans investing in something common, we introduce it as a new sub-asset class in our survey and begin benchmarking it from there.
For niche sub-asset classes, such as Ugandan equity or Swiss bonds, where there is not enough data available for a meaningful comparison, CEM provides genericized categories titled “other,” such as other public equity, other fixed income, or other real assets.
Sub-asset classes reported under “other,” or any sub-asset classes where sufficient data is not available, are benchmarked to their own cost. In practice, this means the cost of these assets is assumed to equal their benchmark cost, so these assets do not affect your total fund relative position against the benchmark. The cost of these assets is still included in your total cost figure, just not held against you in the peer-based comparison. We will take a deeper look at our benchmark cost model in an upcoming blog.
Our committment to you
The trust our subscribers have placed in us over the years, many for close to a decade without interruption, is something we take seriously. This series is one way of honouring that trust. We are not here to simply explain ourselves. We are here to open a dialogue that pushes our work, and the industry, forward.
We look forward to hearing from you. If there is a question you would like us to address, please reach out to us at insights@explorecem.com.
This blog is part of our “Opening the Black Box” series. If you’d like to receive new posts in your inbox, please click here to subscribe.