In ordinary English, a benchmark is a standard of performance, used as a point of comparison. In investment management, this definition has been extended in a precise way (Siegel 2003, p. 4):
The benchmark for portfolio performance is the total return on a (usually) cap-weighted index of the securities in the asset class, or subclass, in which the portfolio is intended to be invested.
Benchmarks play several roles in investment management. In one sense, benchmarks are passive investment strategies to compare against an active manager's performance and to determine whether the manager has added value. In another sense, benchmarks represent the opportunity set of investments in an asset class; a well-constructed benchmark measures the return from an investment in that asset class. Finally, a benchmark represents the aggregate return of all investors in an asset class, whether invested actively or passively, before fees and costs.
WHAT ARE BENCHMARKS FOR?
The three main uses and purposes of benchmarks are listed next.