What benchmarks mean for asset classes, investors and fund managers

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In the investment world, benchmarks are essential when comparing fund performances across all asset classes, including equity, fixed income, etc. Creating benchmarks has been an evolving science. Finding a precise and accurate benchmark is a process that comes with its own challenges and a number of factors need to be carefully considered before selecting the one that will work for you.

What makes for a good benchmark?

Unambiguous: The benchmark’s methodology and constituents should be transparent and readily available. The way a benchmark is constructed should also be available and known to all.

Investable: It should allow the investor to cease active management and just hold all its constituent securities. This means that the benchmark’s constituents should be liquid and accessible, allowing for a fully replicable implementation of the investment strategy.

Measurable: The benchmark should allow for returns to be easily calculable and on a reasonable frequency. The methodology should be so transparent that its performance over the horizon is calculable.

Relevance: The benchmark should be relevant to the investor’s investment objectives. It should ideally bear a close resemblance to the underlying strategy. For example, if a fund is thematic and invests in Infrastructure, it is irrelevant to have a Banking Index as the benchmark or a mid-cap fund with Nifty 100 as the benchmark.

Reflective of investment opinion: Managers have current investment knowledge, regardless of whether the knowledge is positive, negative, or neutral, of the securities, or they can factor exposures within the benchmark.

Transparency and stability: It should be specified in advance and before the start of an evaluation period, and its calculation