Relevant Benchmarks

Lesson

Benchmarks help investment professionals and clients compare the performance of their investments against a standard or a specific market index.

Practice Question #1

Which of the following is a measure of the excess return of a portfolio relative to its benchmark?

A) Alpha

B) Beta

C) Sharpe Ratio

D) Information Ratio

Select an option above to see an explanation here.

A) Alpha is a measure of the excess return of a portfolio relative to its benchmark. B) Beta measures the sensitivity of a portfolio's returns to the overall market returns. C) Sharpe Ratio is a measure of the risk-adjusted return of a portfolio. D) Information Ratio measures the risk-adjusted return of a portfolio relative to its benchmark.

Terms

Benchmark:: A standard or point of reference against which the performance of a portfolio can be measured.

Practice Question #2

What is the main purpose of using relevant benchmarks in portfolio performance evaluation?

A) To predict future returns

B) To compare the performance of a portfolio against a standard or market index

C) To determine the risk level of a portfolio

D) To calculate the fees associated with a portfolio

Select an option above to see an explanation here.

A) Benchmarks are not used to predict future returns. B) The primary purpose of using relevant benchmarks is to compare the performance of a portfolio against a standard or market index. C) Benchmarks can help assess the risk level of a portfolio, but it is not their main purpose. D) Benchmarks are not used to calculate fees associated with a portfolio.

Historical Example

In the 1990s, many investors compared their portfolio performance to the S&P 500 index, which experienced significant growth. This led to a widespread belief that any investment strategy should be able to outperform the S&P 500. However, this benchmark was not appropriate for all types of portfolios, as it only represented a specific segment of the market and did not account for the risk associated with different investment strategies.

Practice Question #3

Which of the following is NOT a relevant benchmark for a portfolio consisting of 100% bonds?

A) A global aggregate bond index

B) A target-date fund index

C) A well-known corporate bond index

D) A major index of Treasury securities with various maturities

Select an option above to see an explanation here.

A) This may work depending on the portfolio composition. B) An equity index is a wrong choice as a benchmark for a fixed-income portfolio. C) This may work depending on the portfolio composition. D) This may work depending on the portfolio composition.

Real-World Example

An investor has a portfolio of 60% stocks and 40% bonds. To evaluate the performance of their portfolio, they can use a blended benchmark, such as a combination of a large-cap equity index (for the stock portion) and an aggregate fixed-income index (for the bond portion). By comparing their portfolio's performance to this blended benchmark, the investor can determine if their investment strategy is effective or if adjustments need to be made.