Investment Basics

Investment Basics: Benchmarks

Learn the basics of benchmarks, including the crucial role a benchmark serves in investing.

  • There are many different fixed interest indexes that can be used as benchmarks for a fixed- interest portfolio.
  • Choosing the right benchmark for a portfolio is important because the benchmark establishes the risk and return parameters for managing the portfolio.
  • The right benchmark for a given portfolio will depend on the investor’s goals for the portfolio, including the required return, the level of short-term and longer-term risk the investor is willing to assume, and other performance characteristics and requirements, including liquidity.

At a glance

A benchmark serves a crucial role in investing. Often a market index, a benchmark provides a starting point for a portfolio manager to construct a portfolio and directs how that portfolio should be managed on an ongoing basis from the perspectives of both risk and return. It also

allows investors to gauge the relative performance of their portfolios; an annual return of 6% on a diversified bond portfolio may seem strong, but if the portfolio’s benchmark returns 7% over the same time period, the bond portfolio

has fallen short of its goal.

The number of benchmarks is virtually endless, and selecting the right one is not always easy. To try to simplify the selection process, we examine:

  • What is a benchmark?
  • How is a benchmark calculated? and
  • How and why might a portfolio’s performance differ from its benchmark?

In Benchmarks: Selecting a Benchmark, we also look at the factors to consider when trying to find the best benchmark for an investment portfolio.

What is a Benchmark?

In most cases, investors choose a market index, or combination of indexes, to serve as the portfolio benchmark. An index tracks the performance of a broad asset class, such as all listed stocks, or a narrower slice of the market, such as technology company stocks. Because indexes track returns on a buy-and-hold basis and make no attempt to determine which securities are the most attractive, they represent a “passive” investment approach and can provide a good benchmark against which to compare the performance of a portfolio that is actively managed. Using an index, it is possible to see how much value an active manager adds and where – that is, through which investments - that value is added.

The following are among the most widely followed share indexes, or benchmarks:

Numerous other equity indexes have been designed to track the performance of various market sectors and segments. Because shares trade on open exchanges and prices are public, the major indexes are maintained by publishing companies like Dow Jones and the Financial Times, or the stock exchanges.

Fixed income securities do not typically trade on open exchanges, and bond prices are therefore less transparent. As a result, the most commonly used fixed income indexes are those created by large broker-dealers that buy and sell bonds, including Barclays Capital (which now also manages the indexes originally created by Lehman Brothers), Citigroup, J.P. Morgan, and BofA Merrill Lynch. Widely known indexes include the Barclays Global Aggregate Bond Index, tracking the largest global bond issuers. The Bloomberg AusBond Composite 0+ Yr Index, is the most widely used Australian fixed interest benchmark.


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