The fund industry has been dealt a damaging blow by its own professional body. It has accused asset managers of selecting inappropriate benchmarks in a bid to market themselves more easily to investors.

The CFA Society of the UK, a body that provides training to 11,000 investment professionals, said it has found evidence of fund managers “misusing benchmarks to demonstrate that they have skill when, in fact, this can just be an illusion”.

In a report issued by the society, examining how fund managers select benchmarks and indices, it found that poor practices range from selecting and using inappropriate benchmarks to overlooking the impact of leverage.

Fund groups might be tempted to misuse benchmarks in this way if they are “more interested in asset gathering than in delivering performance to clients”, said Will Goodhart, chief executive of CFA UK.

Jake Moeller, head of UK research at Lipper, the data provider, agreed there was scope for benchmarks to be misused.

“Benchmarking can certainly be manipulated if the fund manager nominates a benchmark that makes them look good in a certain sector. That is a problem,” he said. “Some smaller houses will try and paint their performance in as good a light as possible when they want to get assets.”

An asset manager could nominate a large-company stock index as their benchmark, for example, but primarily invest in mid-sized companies, Mr Moeller said. This could unfairly flatter their performance.

Mr Moeller said it was unlikely that “reputable” fund houses engaged in such practices. “I do not think fund groups are that cynical. Most fund managers work on a best-practice basis and reputable fund groups do not want to be seen to be manipulating benchmarks,” he said.

Mr Goodhart urged investors to ask more questions of their asset managers about which benchmarks have been selected in order to tackle this problem. He added that regulators might apply more scrutiny to benchmark selection.

Dominic Johnson, chairman of the New City Initiative, an association representing 49 asset management companies, said regulatory attention was unnecessary. “I am always loath to encourage greater scrutiny from regulators — then you got box-ticking,” he said. “I don’t think [benchmark selection] needs regulatory control but it does need greater education.”

CFA UK also criticised the industry for failing to highlight additional costs to investors when marketing new products to them, particularly with respect to the increasingly popular smart beta category of funds — strategies that aim to provide a better risk/return trade-off than traditional market capitalisation-weighted indices.

“All too often innovation in the world of indices overlooks the necessary cost-benefit analysis. While new indices might look more attractive than traditional cap-weighted indices, it is rare for providers to indicate the additional costs involved. These alternative indices vary in terms of their costs and net benefits,” the report said.

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