Investors often know they should use index funds, but still need the specific asset allocation for their risk profile.
Why should clients seek out investable benchmarks?
Jason Laurie, Altair Advisers, 6/4/14
Benchmarks are fundamental measuring tools that gauge the relative performance of securities, investment managers and portfolios. They help answer the question, “How are my investments performing?” Yet despite their importance, they often have inherent shortcomings that can make them less than optimal for evaluating performance.
One of the most significant flaws is that indexes, not index funds, are widely used as benchmarks to compare performance. That may seem like a distinction without a difference, but it is not. Indexes are theoretical; they represent a group of securities without any costs and free from all the practicalities of implementing a portfolio, whereas, index funds are the real thing. Not surprisingly, the performance of an actual index fund may differ considerably from that of the index benchmark it is attempting to replicate.
So why aren’t investable benchmarks the norm? Blame habit and practicality. It has long been good enough to select an index based only on whether it best represents the active manager’s investment style and not on the practical implications of investing in the index. Also, it can be difficult to identify funds that accurately replicate many of the widely used indexes. Thus even the term “investable benchmark” is not widely used in the investment world.
But that world is changing.
The CFA Institute, a global association of investment professionals, notes in its guidelines that a tenet of investing fundamentals is to have benchmarks that, among many other characteristics, are investable—a crucially important property but perhaps the hardest to achieve. In other words, it should be possible to forgo an active manager and simply invest in the benchmark.
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