Benchmarks Explained

Topic: CRM2

James E. Houston CIM, FCSI

January 12, 2017

Image used with permission: iStock/BrianAJackson


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Benchmarks Explained

A benchmark is defined as “a point of reference from which measurements may be made”, or “something that serves as a standard by which others may be measured or judged”.1 Benchmarking is a common practice of measuring many things, from student evaluations to business processes. In the case of investment management, it is generally used to measure or grade investment performance.

At Nexus, for instance, when we report the performance of our pooled funds, we also compare it to the performance of the funds’ respective benchmarks. Each of our four funds has its own benchmark which is relevant to the mandate of the specific fund.

Benchmarks are usually made up of a blend of common broad market indices. As an example, the objective of our Nexus North American Balanced Fund is “to provide superior long-term investment returns through a balanced portfolio of equity and debt securities”. As such, and because it is a North American fund, the benchmark that we compare our fund’s performance to has components representing cash, bonds and Canadian and U.S. equities. Specifically, the blended benchmark of our Balanced Fund is (and always has been):

Cash – 5% FTSE TMX Canada 91-Day T-Bill Index
Bonds – 30% FTSE TMX Canada Universe Bond Index
Canadian Equities – 40% S&P/TSX Composite Index (Total Return)
U.S. Equities – 25% S&P 500 Index (Total Return) (in CAD$)

When constructing a benchmark for a fund there are certain essential characteristics that it must have:2

  • Unambiguous. The identities and weights of securities are clearly defined.
  • Investable. It is possible to simply hold the benchmark.
  • Measurable. The benchmark’s return is readily calculable on a reasonably frequent basis.
  • Appropriate. The benchmark is consistent with the manager’s investment style or area of expertise.
  • Reflective of current investment opinions. The manager has current investment knowledge of the securities in the benchmark.
  • Specified in advance. The benchmark is specified prior to the start of an evaluation period and known to all interested parties.
  • Owned. The investment manager should be aware of and accept accountability for the constituents and performance of the benchmark.

Presenting our funds’ performance against a benchmark allows our clients to see how we have performed in a particular market environment over similar periods of time, and provides us with evidence to determine whether our funds are meeting their objectives.

These days, Exchange Traded Funds (“ETFs”) allow do-it-yourself investors to readily build portfolios that replicate benchmarks. But determining an appropriate mix that is personalized for the investor’s financial circumstances and risk tolerance is difficult. Apart from ongoing monitoring and re-balancing, managing the behavioural bias to buy high and sell low that is common to all investors, is tremendously challenging.

At Nexus we have learned that successful long-term investing comes from having a financial plan that establishes a strategic asset mix designed to your personal investment objectives. When integrated with an investment manager who keeps you from doing the wrong thing at the wrong time, and whose “active” investment style and stock selection protects capital in down markets, your chances of long-term wealth creation greatly improve.

We have written in the past about ETFs and “passive” investing. Our blog ETFs and Risk – What Clients Are Asking Us from 2013, is still relevant today and can be found here.

1 Benchmark www.merriam-webster.com
2 Managing Investment Portfolios: A Dynamic Process (CFA Institute), Third edition, John L. Maginn, CFA, Donald L. Tuttle, CFA, Jerald E. Pinto, CFA, Dennis W. McLeavey, CFA.

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