It’s All Relative

I see that one of our recent blogs addressed the change of benchmarks on our client quarterly reports. I thought this would be an appropriate time to be a major buzz kill and hit you up with all kinds of technical mumbo-jumbo about what makes a good benchmark. I’ll try to make it light and amusing (I don’t know about you, but I’m already laughing).

Fortunately, I just finished reading the section on benchmarks in my CFA study material (yes, I’m still working my way through those exams – this marks year MMLXXVII in my progress…). The authors of my study guide suggest the acronym, “SAMURAI” to help you remember the seven properties of a good benchmark. (For me, “samurai” brings to mind hara-kiri, a form of Japanese ritual suicide by disembowelment, which is what I feel like doing every time I have to sit down and study this stuff.)

Before I continue, I just want to point out that the whole reason for even having a benchmark is so that you can compare your portfolio’s performance to something similar. It’s kind of like the investment management version of a high school reunion – you thought you were pretty successful until you found out that nerdy guy from homeroom had invented some kind of social networking site…you thought you were out of shape until you saw what happened to the head cheerleader…

Back to the acronym. A valid benchmark should be specified in advance, appropriate, measurable, unambiguous, reflective of the manager’s current investment opinions, accountable, and investable (I’d like to mention that MS Word doesn’t recognize the word “investable” and instead recommends “ingestible.” Mmm, benchmark…).

So, the manager should choose the benchmark at the beginning of the reporting period (you know, so she doesn’t wait until afterwards and pick a benchmark that underperformed the portfolio, just to make her look good) and it should be comparable to the portfolio in terms of style (i.e., you wouldn’t want to compare a portfolio of large cap domestic stocks to a small cap emerging market index). The benchmark should have a return that is measurable and a value that is frequently updated, with clearly identified securities whose weights are known. The manager should have current investment knowledge of the securities in the benchmark, and be familiar with the benchmark’s performance, with active management accounting for differences in portfolio construction (and performance) versus the benchmark. Lastly, an investor must be able to replicate the benchmark by buying securities that mimic its composition (or be able to eat it, according to Microsoft).

If you scroll down a bit and read Bill’s blog about the benchmarks displayed on quarterly reports, you’ll notice that we’re specifying the new benchmarks in advance, and we’re doing so because they better reflect the composition of our clients’ portfolios, compared to the old benchmarks. In addition, they’re all investable (you can purchase ETFs that mimic the indices mentioned). But I wouldn’t try to eat them, if I were you.

Sarah DerGarabedian, Research and Trading Associate

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