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.
A benchmark is a point of reference for measuring performance. A choice of benchmark can greatly influence decisions throughout the investment process. When selecting investments such as mutual funds or separately managed accounts (discretionary portfolios), benchmarks are useful to assess a fund manager’s skills and track record.
Benchmark Indexes
Benchmark indexes have been created across all types of asset classes. In the equity market, the S&P 500 and Dow Jones Industrial Average are two of the most popular large cap stock benchmarks. In fixed income, examples of top benchmarks include the Barclays Capital US Aggregate Bond Index, the Barclays Capital US Corporate High Yield Bond Index and the Barclays Capital US Treasury Bond Index.
The Good
Good benchmarks increase the proficiency of performance evaluation and enhance the plan sponsor’s ability to control total portfolio risk.
The Bad
Bad benchmarks obscure manager skills and promote inefficient manager allocations, and increase the likelihood of unpleasant surprises in total fund performance.
The essential properties of a benchmark
The essential properties that an investment benchmark should possess are as follows:
1. Specified in advance – the benchmark needs to be known before and investment manager starts managing a portfolios
2. Appropriate – the benchmark is in line with the manager’s style of investing
3. Measurable – the benchmark’s return can be easily calculated
4. Unambiguous – the identities and weights of securities can be clearly identified
5. Reflective of current investment opinions – the investment manager knows the companies in the benchmark and has an opinion on them
6. Accountable - The manager is aware and accepts accountability for the constituents and performance of the benchmark
7. Investable – you can actually buy the benchmark
These qualities are easily remembered through the acronym SAMURAI.
Conclusion
Irrespective of whether you manage your own portfolio or you opt of a discretionary managed service, it is always important to measure performance not only to see whether your portfolio outperformed the market in general, but also to learn from your mistakes and improve your investment skills.
Disclaimer:
This article was issued by Kristian Camenzuli, investment manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri Investment Services Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website.