Business is a good game – lots of competition and a minimum of rules. You keep score with money.
Atari founder Nolan Bushnell (1943-)
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 return and risk against an appropriate benchmark.
Benchmark is defined in the Oxford English Dictionary as a standard or point of reference. 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.
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 client’s requirements.
2. Investible. The portfolio 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 portfolio manager has no control.
3. Accessible. To allow the portfolio manager to construct the portfolio against the benchmark it is essential that there is access not only to the returns of the benchmark but to the constituent elements and their weights at the start of the period of measurement.
4. Independent. An independent third party should calculate all benchmark return to ensure a fair comparison.
5. Unambiguous. The chosen benchmark should ...