An investment benchmark is a standard against which the performance of a portfolio or an investment manager can be measured.

On average, investment managers underperform benchmarks after their fees are deducted.


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Different asset classes exhibit different risk and return characteristics. The use of passive benchmarks serves to represent those risk and return characteristics as used in an asset mix study leading to the optimal strategic asset allocation mix. The quality of active management mandates are measured against such benchmark.

The "SAMURAI" properties of a valid benchmark are (Managing Investment Portfolios: A Dynamic Process (CFA Institute Investment Series), by John L. Maginn, Donald L. Tuttle, Dennis W. McLeavey and Jerald E. Pinto, 2007):

  • Specified in advance: Benchmark specified and known before the before the evaluation period.
  • Appropriate: Consistent with the manager’s investment style or area of expertise.
  • Measurable: The benchmark’s return is readily calculable on a reasonably frequent basis.
  • Unambiguous: Identities and weights of securities or factor exposures are clearly defined.
  • Reflective of current investment opinions: Current knowledge of securities/factor exposure.
  • Accountable/Owned: Manager should be accountable for the constituents/performance.
  • Investable: Can hold the benchmark.

Furthermore, Jeffery Bailey lists other important factors to consider in evaluating benchmark quality including (Evaluating Benchmark Quality, by Jeffery V. Bailey, Financial Analysts Journal, May-June 1992, pp. 33- 39):

  • High coverage.
  • Low turnover.
  • Reduced observed active risk.
  • High correlation between the managed portfolio and the benchmark.
  • Similarity of managed portfolio and benchmark style exposure.

He comments that:

  • Good benchmarks increase the proficiency of performance evaluation.
  • Good benchmarks enhance the plan sponsor’s ability to control total portfolio risk.
  • Poor benchmarks obscure manager skills.
  • Poor benchmarks promote inefficient manager allocations and increase the likelihood of unpleasant surprises in total fund performance.

I would add that poor benchmarks make it difficult to do proper asset mix studies which leads to flawed asset mix recommendations. Some proposed benchmarks do not have live historical data and sometimes include back filled data which contains significant survivorship biases.

In order to avoid negative surprises, stay away from managers who do not care or do not beleive in benchmarks.  The truth is: passive benchmark investing is difficult to beat.  The majority of active managers have difficulty beating them on a consistent basis.

For more information on Benchmark and how to properly choose them, please contact us.

Dominic Clermont, ASA, MBA, CFA


State of the Art Investment Management