Practical Portfolio Performance Measurement and Attribution, 3rd Edition

4Benchmarks

No one can hit their target with their eyes closed.

Paulo Coelho (1947–)

Business is a good game – lots of competition and a minimum of rules. You keep score with money.

Atari founder Nolan Bushnell (1943–)

BENCHMARKS

Measuring the return of a portfolio in isolation provides only part of the story; we need to know if the return is good or bad. In other words, we need to evaluate performance (risk and return), against an appropriate benchmark.

Benchmark is defined in the Oxford English Dictionary as “a standard or point of reference against which things may be compared”. Not readily translated into other languages, it derives from a surveyor's mark cut in a wall and used as a reference point in measuring altitudes.

Benchmark attributes

Good benchmarks should have the following attributes:

1. Appropriate

   The chosen benchmark must be relevant to the appropriate investment strategy. It is essential that the benchmark matches the asset owner's requirements.

2. Investable

   The asset manager should be able to invest in all the securities included in the benchmark. If not, there will always be an element of relative performance for which the asset manager has no control.

3. Accessible

   To allow the asset manager to construct the portfolio relative to the benchmark it is essential that there is access not only to the return information of the benchmark but the constituent elements and their weights at the start of the period of measurement.

4. Independent

   An independent third party ...