The benchmark is a benchmark used to measure the performance of an investment. It is a financial indicator used as a comparison tool to evaluate the performance of an investment.

The word benchmark comes from English and means 'benchmark' or 'parameter'. It is also used in marketing to reference a successful product or technique.

In finance, when evaluating the performance of an investment, it is important to compare it with a benchmark, since given the wide variety of investment possibilities, it is not the same to compare the performance of a person who invests in bonds, stocks or real estate. For example, to measure the performance of the portfolio of a Spanish equity investor, a stock index such as the Ibex 35 can be used as a benchmark, and thus know if it has obtained more profitability than this index, or on the contrary, the investor will It would have been more profitable to invest directly in the Ibex 35, through a financial derivative, such as an ETF.

The benchmark will be chosen depending on the market to which the investment is oriented, the style of the investor and the types of financial asset in which it can be invested, among other factors. A combination of several indices can even be used as a benchmark, if the investment is focused on several markets.

Therefore, the benchmark of an investment fund will be the reference index used to contrast the behavior of this fund in comparison with a standard fund in a time frame. In this way, it is possible to determine whether the fund manager has obtained a return thanks to his investment skills. It helps the investor to know if he is interested in investing in that investment fund, or on the contrary, investing directly in it. benchmark, reducing your management costs.

Functions of a benchmark

Each mutual fund is based on a benchmark that best suits its objectives. Among the advantages or functions that we can attribute to the use of this technique are:

  • It helps the manager to define the destination of the investment, having clear instructions on which markets and types of assets to invest in.
  • It serves so that the clients of the investment fund know in which they are going to invest.
  • It is very useful to identify the risks of the investment.
  • Simplify the interpretation of returns.
  • It is a tool with which the investor compares and evaluates his current and historical performance.
  • In case of positive returns, it can be used as a marketing tool.
  • Demonstrates compliance with financial standards and regulations.

Properties of a good benchmark

Benchmarks are very useful to deal with the complexity in measuring investment returns, but not all benchmarks are equally efficient. In order to categorize the properties that make a benchmark an effective benchmark, the CFA Institute has published a series of criteria:

  1. Be specified in advance: The benchmark to be used must be known before making any investment.
  2. Appropriate: It must be consistent with the manager's style.
  3. Measurable: Its value and performance can be determined relatively frequently.
  4. Unambiguous: Its components must be clearly defined.
  5. Related to the manager's area of ​​knowledge: It must coincide with the manager's investment objective.
  6. Acceptability: The manager must agree to the use of this benchmark
  7. Invertible: You can invest in the benchmark with relative ease.

Benchmark types

There are many types of benchmarks, the seven most used types are:

  1. Absolute return benchmark: For example, a 5% annual return. It is a very simple technique although it cannot be used as an investment alternative.
  2. Managers universe: The average performance of all managers in a market is used as a benchmark. It is very easy to measure but it cannot be known in advance nor is it invertible.
  3. Based on general indices: Use, for example, the Ibex 35. It fulfills the properties of a good benchmark.
  4. Based on the style of the indices: They use a specific investment style as a benchmark, such as a value strategy in large caps.
  5. Factor-based or model-based: Specify a set of factors to use as a reference.
  6. Based on past returns: They are built using an algorithm that combines the different investment styles that reflect the past investments of a fund.
  7. Based on personalized values: It uses for its composition specific values ​​from the manager's investment universe to build that benchmark.

Tags:  opinion bag markets 

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