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December 2019

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Benchmark Discussion

Alan Leist III | Articles

Read Time: 5:30 min

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Discussion Objective: Describe Strategic’s process for measuring the performance of our investment strategy within the context of a client’s risk and return objectives.


The evaluation of an investment manager is a multifaceted process that combines quantitative and qualitative criteria. Factors to consider generally fall under one of the “Six P’s” as introduced by the CFA Institute.

Organizational Structure
Investment Professionals
Investment Philosophy
Decision Making
Quality Control
Absolute Returns
PerformanceRelative Results
PriceTotal Management Fees

Within this framework, the choice of appropriate benchmarks is an important and nuanced decision that must be approached thoughtfully by fiduciaries in order to effectively evaluate performance results relative to the organization’s goals. The insights gained from measuring investment results versus a benchmark are only as valuable as the quality of the benchmark itself, which is dependent on the clarity of the client’s objectives.

Developing an Appropriate Benchmark

An investment benchmark is a standard by which the performance of a security or portfolio can be measured. As defined by the CFA Institute, a proper benchmark should satisfy a strict set of criteria in order to be considered a valid evaluation tool. A benchmark should be:

  • Unambiguous: Factor exposures within the benchmark are clearly identified and weighed.
  • Investable: A passive investment strategy that mirrors the benchmark should be available to the investor that wishes to forgo active management.
  • Measurable: Benchmark performance should be readily available and easily determined.
  • Appropriate: The style of the investment manager should be accurately reflected in the selected benchmark.
  • Reflective of Current Investment Opinions: The manager has an understanding of the investment characteristics of the factors underlying the portfolio benchmark.
  • Specified in Advance: At the onset of an evaluation period, the benchmark is established and known to all.
  • Owned: The manager is expected to be held accountable for performance relative to the benchmark.

Measuring the Value of Active Management

Return differentials that exist between a benchmark index and the portfolio being evaluated are the result of the value added by “active management” (net of fees and transaction costs) as well as the client’s unique risk objective. The latter point is a subtle, but important one. It is not enough to know whether the return differential is positive or negative; we must also factor in whether those differentials were achieved at an appropriate risk level for the client. If the risk of the benchmark does not match the client’s unique risk objectives, a return differential would be expected.

Superior portfolio performance can be generated on two fronts: security selection and asset allocation. In the context of the overall investment portfolio, a properly defined benchmark will enable fiduciaries to determine whether a manager was successful in both of these pursuits. Benchmarks are rarely perfect, however, and subjective judgment is often needed to determine whether the investment manager has helped the client reach their goals.

We should note that Strategic does not manage to benchmarks, as that practice can lead to the assumption of unintended risks. However, we do use indices as one general reference point in evaluating our success in the pursuit of a client’s goals.

A Word about Risk

The ability and willingness of a client to take risk includes multiple objective and subjective factors. The  traditional risk metric of volatility alone does not fully capture a client’s risk profile. Factors such as tracking error, shortfall, permanent loss of capital, costs, currency exposure and donor wishes should be considered.


Performance reporting is enhanced by an evaluation framework that considers multiple perspectives consistent with the goals of the organization. In particular, we promote the use of a Composite Index and a General Index.

Composite Index

The Long-Term Target Portfolio Allocation as set forth in the investment policy statement is used to construct the benchmark referred to as the “Composite Index”.  The Composite Index is the most relevant yardstick for comparison, as it correctly addresses each of the key criteria for a properly defined benchmark. The value of active management is clearly demonstrated, as asset allocation decisions and single security selection will drive relative performance versus the composite.

The Long-term Target Allocation and corresponding Composite Index are reevaluated on a regular basis to ensure that they remain consistent with the mission of the organization. A change in factors such as risk profile, cash flow projections or the global market portfolio would be considered when assessing the suitability of the Index and a potential change.

General Index

The General Index is most useful in helping to add context to the value added by the manager and the investment committee in setting the Long-Term Target Allocation. A General Index (Example: 70% S&P 500/30% Barclays Intermediate Term Aggregate Corporate/Government) is constructed to represent the returns of a passive, non-diversified strategy. Comparison to this benchmark will help to gauge the impact of diversification and provide a more traditional look at relative performance against common indices.

While benchmarking can be a useful piece of the evaluation process, the only true criteria for measuring investment results, as mentioned earlier, is in relation to the long-term goals of the client.

Source: Bailey, Phillips and Richards “A Primer for Investment Trustees (A summary)” CFA Institute, 2011.

About Strategic

Founded in 1979, Strategic is a leading investment and wealth management firm managing and advising on client assets of over $2 billion.