BENCHMARKS: THE REAL THERMOMETER OF INVESTMENTS
The importance of comparing performance with the right index
Many investors make the mistake of using the wrong index—or not using one at all—to evaluate their portfolios. This choice is crucial, as an appropriate benchmark helps determine whether the returns achieved are truly competitive relative to the market. In this article, we review how benchmarks differ across fixed income, equities, and alternative assets, why choosing the correct one helps avoid misleading interpretations, and how measuring excess return provides a clearer, fairer, and more accurate view of an investment’s true performance.
The importance of comparing performance with the right index
Choosing the right benchmark is essential for any investor seeking to accurately measure portfolio performance. A benchmark acts as an indicator that allows investors to assess whether their investments are generating satisfactory results compared to the market or similar assets. However, it is common for investors to use inappropriate indexes or none at all, which can lead to a mistaken perception of their performance.
In the equity space, for instance, it is crucial to select an index that reflects the sector or region in which one is investing. An investor holding technology stocks should compare performance against an index that includes such companies—like the Nasdaq or a specific index such as the MSCI World Information Technology—rather than a broad market index that does not capture the portfolio’s specific focus. In fixed income, benchmarks also vary considerably depending on the type of asset and its duration. A corporate bond fund, for example, should be evaluated against a corporate bond index, not a government bond index. This distinction is vital, as risks and returns can be significantly different.
When analyzing alternative assets, such as real estate or private equity funds, selecting the appropriate benchmark can be even more challenging, as these assets often lack standardized reference indexes. In these cases, measuring excess return—meaning the return achieved relative to a risk-adjusted benchmark—becomes a fundamental practice for evaluating the success of the investment.
In conclusion, using the right benchmarks not only provides a clearer view of portfolio performance but also empowers investors to demand fair and accurate comparisons. By understanding how and why to use the correct indexes, investors can make more informed and strategic decisions.