Benchmark

Benchmarks serve the important function as a standard of performance measurement, helping investors determine to what extent an investment has achieved its investment objective and added value of the investment manager. Since Valedictory I is a portfolio of different asset classes, we must therefore compile an appropriate composite of underlying asset class indices.

Properties of a Valid Benchmark

According to performance evaluation experts, a good benchmark should ideally be ‘SAMURAI’:

  1. Specified in advance: decided prior to the start of the evaluation period, to avoid post-hoc bias
  2. Appropriate: relevant to the portfolio being measured, in terms of investment style or category
  3. Measurable: readily available data and calculable on a frequent interval basis
  4. Unambiguous: the constituents and their weights are clear, and calculation methodology is transparent
  5. Reflective: of the broad investment universe and risk characteristics of the portfolio
  6. Accountable: the manager agrees to the benchmark for performance measurement
  7. Investable: it is possible to simply replicate and buy the benchmark

In addition to these properties, I think it is preferable for the benchmark to: have a long operating history, be generally recognized or popularly accepted by investors, and in the case of index fund product proxies, to have a low expense ratio.

Common Problems

Many common investment benchmarks do not satisfy all the properties above.  Often, a cited benchmark is not very relevant or is not completely investable (e,g. fees and illiquid bonds). Peer groups may be not known in advance or are not completely unambiguous or measurable.

Benchmark Type  Description Advantages Disadvantages
Absolute Minimum return of x%
  • Simple and clear
  • Not directly investable
Manager’s Universe ‘Universe’ of similar managers, using the ‘median manager’ as the benchmark
  • Simple to measure
  • Cannot be specified in advance
  • Survivorship bias
Broad Market Indices e.g. S&P 500
  • Recognized, understandable, and widely available
  • Unambiguous and investable
  • Not very relevant for idiosyncratic or niche styles
Style Indices e.g. Large-cap value, Large-cap growth, Small-cap value
  • Available and accepted
  • Typically more appropriate than broad indices
  • Index may significantly overweight certain securities
  • Styles not always clearly defined
Factor-model Indices Regression-based statistical model using exposure to various return drivers
  • Typically more reflective of the underlying investment style or strategy
  • Useful for performance evaluation measurement
  • Not easily understood by or clear to the average investor
  • Not easily investable
Returns-based Created by an algorithm that incorporates the manager’s past returns and those of several style indices.
  • Easy to understand and use
  • Easy to calculate
  • The style indices used may not be appropriate or reflective of investment strategy
Customized Custom-built index provided by an investment consultant that matches a manager’s style.
  • Meets most, if not all, the required qualities
  • Lacks transparency
  • Difficult/ expensive to build and maintain
Our Benchmark

Benchmark for Valedictory I: Lipper Mixed-Asset Target 2030 Funds Index

[[We chose this benchmark because it best satisfies the four characteristics of an ideal benchmark. The Lipper Mixed-Asset Target 2030 Funds Index is an equally-weighted average of the largest retirement target-date funds available in the U.S. mutual fund market. The representative group includes popular funds from: Vanguard, Fidelity, Barclays, and T. Rowe Price. These component funds approximate the asset class exposures and risk characteristics of Valedictory I, as well as share an investment objective of steady return to managed risk through a strategic asset allocation approach.  The funds and the index have several years of performance history.  To the typical investor in Valedictory I, they represent readily investable (though in our opinion inferior) alternatives.  Furthermore, the component funds and data provider Lipper are visible industry leaders, highly recognized by investors.]]

[[We benchmark the performance of our portfolio both to easily recognizable market benchmarks, and to a universe of comparable investment managers.  Our experience has shown us that most retail (and many institutional) investment programs are inherently structurally disadvantaged, there exist certain managers and processes that we ourselves admire and believe in.  Passive investing– using low cost, index-like vehicles to achieve exposure to markets, is a process we believe is fundamentally sound– but one we have very high confidence we can beat.  Therefore, we will also measure our success in our ability to exceed the performance of a relevant passive benchmark.]]

Passive benchmarks are not perfectly ‘investable’.  Most funds employ a passive index benchmark such as the S&P 500 Composite Index or the Lehman Brothers Aggregate Bond Index.  While passive benchmarks afford the advantage of having reliable historical performance data compiled by the index provider, they do not reflect fees (management and brokerage) nor cash drag that are inherent in real investable investment vehicles.

High recognition, low relevance.  For performance measurement, investors are apt to equate the “stock market” to popular indexes like the Dow Jones Industrial Average or the S&P 500 Composite Index.  However, these indexes measure the performance of only the U.S. liquid equities market, which by market capitalization is not even half of the world equities market.  Furthermore, these two indexes do not include the performance of non-equity asset classes such as bonds and commodities.  Therefore, they are inadequate benchmarks for a global multi-asset class portfolio like Valedictory I.

An investable alternative.  An ETF or index fund that attempts to track the S&P 500 Composite index would be, in our opinion, a legitimate candidate for a large-cap portfolio benchmark.  Similarly, a money market account would be a legitimate candidate for a market-neutral portfolio benchmark.  Both are reflective of the risks of the benchmarked portfolio and are easily investable.  Unfortunately, no ETF or index fund tracks the comprehensive set of asset classes that Valedictory I is exposed to.  Cognizant our shareholders would likely have invested in either a large-cap fund or conservatively, a money market fund, we include the S&P 500 Composite Index and the 3-month Treasury Bill Index in our performance data strictly as auxiliary references.  Similarly we include the Core CPI index, which is constructed by the U.S. Government (and susceptible to measurement inconsistencies by the government).

Lipper and Morningstar category index.  While Valedictory I is not a mutual fund and thus has not been categorized by Lipper or Morningstar, the fund closely shares risk characteristics and asset class exposures with the Lipper Target Allocation Growth/ Lipper Target Date 2030 and the Morningstar Target Date 2019-2029 categories.]]

  • Index
    • Stock Market (investible): iShares Core S&P 500 ETF (IVV)
    • Traditional Balanced Fund: Vanguard Balanced Index Inv (VBINX)
    • Global Balanced Fund: Vanguard LifeStrategy Moderate Growth Inv (VSMGX)
    • Global Market Portfolio 1 (Passive): Vanguard Target Retirement 2020 Inv (VTWNX)
    • Global Market Portfolio 2 (Active): T. Rowe Price Retirement 2020 (TRRBX)
  • Alternatives References:
    • Inflation: Consumer Price Index for All Urban Consumers (CPI-U)
    • Cash: SPDR Bloomberg Barclays 1-3 Month Treasury Bill ETF (BIL)
    • Bond Market: iShares Core U.S. Aggregate Bond ETF (AGG)
    • Real Estate (Residential) Market: S&P Case-Shiller U.S. National Home Price Index
    • Peers: Lipper Mixed-Asset Target 2030 Funds Index
Asset Class Benchmarks
  • Asset Classes: benchmarks for various primary and sub-asset classes