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Benchmark Misfit Risk: Identifying the Risk Contribution Arising from Differences in Manager and Policy Benchmarks

The benchmark misfit effect arises when the policy benchmark and the manager benchmark are not aligned. Unless this effect is specifically modeled, it is not possible to determine how the active risk of an individual manager contributes to the risk of the overall fund. In this Research Insight, we showed how the classic Brinson model could be extended to account for benchmark misfit. We also demonstrated how to properly attribute overall portfolio risk to the active risk from an individual manager and the risk contribution from benchmark misfit.