The benchmarking process is a key step in the management of institutional portfolios. Measuring progress against specific objectives is valuable in determining the success of the investment program. Benchmarking should be the easy part, but, as we often find, it can add complexity and confusion to an already complex process.
In this short series of two papers on benchmarking, we explore the challenges of defining, using, and understanding appropriate benchmarks, starting with a discussion on the importance of accurately defining what success means for your organization. We will continue the series contrasting the roles and sources of information provided by different benchmarks at different times — including the impact on selection of market, policy, and specific manager benchmarks — and will delve into the additional complexities that can accompany measuring alternatives and multi-asset portfolios. Readers should walk away from the series with better processes for establishing appropriate objectives and benchmarks, and better equipped to determine if the right conclusions can be drawn from the benchmarks established for their investment programs.
Every investment committee is tasked with the job of achieving its institution’s investment objectives. Most committees attempt this feat through similar processes
- Determine an asset allocation strategy that suggests a reasonable long-term return with an appropriate consideration of risk.
- Implement that strategy through various combinations of managers and available portfolio structure options.
- Periodically report on progress.
The most common method of evaluating progress is to apply a set of benchmarks to measure the results of the underlying managers and the resulting roll-up. Sound familiar?
As a fiduciary and investment committee member, how do you decide whether you have been successful? Is it beating your peers’ performance, or is it outperforming a market or policy benchmark that reflects your own? Or do you measure success relative to the impact the capital has for the organization you cherish?
The answer is most likely some combination of all three. Investors often assume measurement and reporting is the simplest and most straightforward part of the overall investment process. Unfortunately, it is not. The selection of benchmarks, and the information value extracted from benchmark comparisons, is an extremely important — and often underappreciated — component of the investment process. Without appropriate attention to benchmark selection and the lessons to be learned from periodic comparisons, the probability of a mismatch of expectations, and subsequent dissatisfaction with results, goes up substantially.
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