Understanding Best-Fit Versus Standard Indexes
Employing both indexes can help you better diversify your investment portfolio and risk.
Question: I've noticed that Morningstar compares my fund with both a "best-fit" index and a standard index. What is the difference between the two, and what purpose does each serve?
Answer: Investors can find a fund's best-fit index on Morningstar.com by clicking on the Ratings and Risk tab on the gray toolbar at the top of a fund's quote page and scrolling down to the section labeled MPT (Modern Portfolio Theory) Statistics.
The standard and best-fit indexes help investors compare the expected volatility and returns of their funds against broad market benchmarks (which can help investors better diversify their holdings). The indexes also allow for comparisons against more specific benchmarks, which brings more significance to measures of return volatility (beta) and excess return (alpha).
Esther Pak does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.