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Stock Performance Benchmarking

An investing strategy used to help determine the different performance aspects of an investment portfolio

What is Stock Performance Benchmarking?

Stock performance benchmarking is a strategy employed by investors to help determine the different performance aspects of an investment portfolio. Investors typically use benchmarking to get a better assessment of a portfolio’s return, how risky it is as a whole, and how to allocate funds within the portfolio to minimize risk and boost return.

 

Stock Performance Benchmarking

 

There are multiple ways to benchmark a portfolio, though most use one or more standard benchmarks that are commonly employed.

 

Summary: 

  • Stock performance benchmarking is a way for investors to understand the potential/current returns of a portfolio, the risks involved with each investment, and how best to allocate funds for the best balance of risk and return.
  • Benchmarks typically involve portfolios – or indices – that are passively managed by an institution and closely track a certain index.
  • Evolutionary strides in the investment world (smart beta investment strategies) make it possible for investors to utilize and reap the benefits of both active and passive investment styles.

 

What Benchmarks Are

Benchmarks are typically portfolios or indices of securities that aren’t managed. They are usually representative of either the market as a whole or of a specific segment or sector within the market. While such portfolios or indices aren’t usually actively managed, institutions often play a passive role in their management.

Among the most commonly used indices are the Standard & Poor’s (S&P) 500, the Russell 1000, and the MSCI. Indices are important because they are designed to represent a variety of assets. Some benchmark indices – such as the Russell 1000 – are used as a broad metric, while other indices are comprised of more specialized asset classes – such as high-yield bonds, small-cap growth stocks, or emerging markets.

 

Mutual Funds and Exchange-Traded Funds

Exchange-traded funds (ETFs) and mutual funds often use benchmarking indices for the purpose of replication. The funds – or portfolios – are structured in the exact same (or almost exactly the same) way that the index is. It is done based on the needs of the portfolio’s manager and/or the needs of those who invest in the portfolio.

The success of an index and its ability to generate returns with limited risk is crucial. For some, a healthy amount of risky investments is suitable. Thus, the portfolio is designed after an index that incorporates investments that may be otherwise too risky for the average investor.

Investors find that passive investment in a fund mimicking a specific index is the only way to invest “in” such an index. However, forward strides in the investment world are helping popularize smart beta strategies for investing. The smart beta approach employs both active and passive investment strategies, allowing investors to take an active role in the investing process with all the benefits of a passive approach. Investors use the passive approach – and benchmarking – to identify the most opportunistic investments available, then actively add the options to their portfolios.

 

Additional Resources

CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following resources will be helpful:

  • Index Funds
  • Risk Management
  • SPDR S&P 500 ETF
  • Investing: A Beginner’s Guide

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