What benchmarks mean for asset classes, investors and fund managers

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