Learn About Investing
What is a benchmark?
Benchmarks are handy for measuring the performance of investments, and in particular the performance of funds.
By comparing the changes in value of the fund to a benchmark over time, you can easily see whether your fund is doing better, worse or the same as the relevant market average.
Active fund managers tend to choose a specific benchmark for each fund. To provide a meaningful comparison, it usually tracks the value of assets similar to those held by the fund.
The most common type of benchmark is a stockmarket index. For example, a fund investing in UK companies might use the FTSE All-Share as its benchmark, because this index tracks UK company share prices.
There are many different financial indices. For instance, some reflect specific industry sectors and can come in handy as benchmarks for more specialised investments. So a technology fund is likely to have a tech stocks index as its benchmark (such as the FTSE techMark).
In some cases, there may not be a single relevant index which exactly reflects the types of asset a fund invests in. To deal with this, a combination of more than one index may be used.
How good is your fund?
Beating the market is the investment goal of active fund managers. After all, if you don’t outperform the market, you might as well stick to passive index funds.
Let’s say the FTSE 100 climbs 4% and your UK equity fund achieves 9% growth. That’s relative outperformance of 5%.
Funds that deliver long-term outperformance are not as common as one might think. Analysis by Which? reveals that only 38% of active funds aiming to beat the FTSE All-Share index managed to do so over ten years. It’s important to bear this in mind when choosing a fund.
Benchmarks are relative
It’s tempting to think that an investment outperforming its benchmark is good and one that is underperforming is bad. It’s not that simple. Comparing a fund to its benchmark is a good yardstick to judge how well it’s managed, but it doesn’t tell the whole story.
Comparing a fund’s performance to a benchmark describes relative performance, not absolute performance. It’s worth remembering that it is possible to lose money while beating a benchmark and, conversely, make money while trailing one.
A) Your £100 investment goes up 10% to £110. The benchmark moved up 20%. You underperform the benchmark while making gains.
B) A second £100 investment goes down 10% to £90. The market benchmark, meanwhile, fell 20%. You outperform the benchmark, but still lost money.
- Benchmarks are a handy way to evaluate fund performance. They can spot whether active fund managers are adding value relative to other alternatives, such as passive funds.
- Fund managers may select benchmarks, but you don’t have to use them. Feel free to use your own measures of success.
- Deciding what to compare is one thing, deciding the most suitable comparison period is another. Some investors are prepared to ride out periods of short-term underperformance, so long as superior performance is achieved in the long run.