Hi,
I am struggling to understand the correct answer of one of the mock question (Asset Allocation Babb , Q2)
The questions asks if a suggested benchmark is correct in being a liability-based benchmark and an absolute return benchmark.
The question refers to this text:
“Babb’s next meeting is with QBT Charitable Trust. QBT manages a large trust that wants to consistently generate a minimum return of 5% on its holdings to match the annual distribution of funds it makes to the projects it sponsors. Although the discussions between Babb and QBT are still in the preliminary stages, Babb suggests building a benchmark based on high-quality fixed-income securities to match the annual disbursements made by QBT. Babb describes the benchmark as an absolute return liability-based benchmark”
The answer states:
Babb’s description is correct. The 5% return requirement makes the benchmark an absolute return benchmark, and the structure of the benchmark using fixed-income securities to produce the 5% return is based on the liability assumed by the fund for sponsoring projects rather than the asset components of the trust. Consequently, the benchmark is liability-based and not asset-based.
I do not understand the part in bold, what is the link between the return requirement and the benchmark being an absoulte return benchmark since the latest in based on a fixed income securities and not simply a target return of 5%?
The high quality fixed income securities could very well turn out to give a return different than 5% no?
Any help appreciated.
The CFAI text book defines an absolute return benchmarl as simply a minimum target return that the manager is expected to beat (e.g 9%).