Step 12
Level: beginner
Benchmark is a reference point that helps determine whether a portfolio is creating value or just reflecting the general market environment. If measured incorrectly, investors can easily reward lucky decisions and punish correct decisions but encounter an unfavorable environment.
Benchmarks must be appropriate to your goals, asset class, currency, risk level and investment scope. Comparing a Vietnamese stock portfolio with a global index or a bond portfolio with growth stocks can lead to wrong conclusions. A good benchmark helps evaluate both relative returns and risks. A single return number is not enough to conclude whether a strategy is good or bad.
By knowing where the returns came from, what risks were taken, and whether the results exceeded the benchmark, investors can improve the process instead of just reacting to the final result.
Benchmark is a reference point that helps determine whether a portfolio is creating value or just reflecting the general market environment.
Measuring performance is not just about showing off results. The goal is to understand whether the strategy worked as expected, whether the risk was worth it, and whether the results came from skill, environment, or luck. A portfolio with high returns but too much risk may not be as good as a more stable portfolio with lower returns and suitable for your goals.
Benchmarks must be appropriate to your goals, asset class, currency, risk level and investment scope. Comparing a Vietnamese stock portfolio with a global index or a bond portfolio with growth stocks can lead to wrong conclusions. A good benchmark helps evaluate both relative returns and risks.
A performance metric always has a range of uses. CAGR does not indicate drawdown. Sharpe does not see all tail risks. The wrong benchmark leads to wrong conclusions. Attribution requires sufficiently good data. So use multiple complementary metrics instead of finding a single number to represent the entire quality of an investment.
Choose a benchmark before evaluating performance, do not change the benchmark after knowing the results.
During each review period, record the absolute return, return relative to the benchmark, drawdown, volatility and main drivers of performance. This helps you distinguish strategic issues from short-term noise, and detect early when the portfolio deviates from its original goals.
Choose an easy benchmark to create the impression that the portfolio is doing well.
A common mistake is to measure results in the way that is most favorable to the story you want to believe. Serious investors need to accept consistent metrics, appropriate benchmarks, and long enough data. Good measurement does not make the results better, but it makes the lessons clearer.
Reference point used to compare performance and risk.
Benchmark combines many indexes according to the target weight of the portfolio.
Portfolio performance compared to benchmark.
There are measures of absolute returns, risk-adjusted returns, benchmark-relative returns, drawdowns, and return attribution.
Some metrics are used to compare strategies, some are used to understand investor experience, some are used to check risk.
Performance metrics depend on data quality, measurement period length, and benchmark suitability.
Application in performance measurement
A portfolio of 80 percent stocks and 20 percent bonds should be benchmarked against a corresponding blended benchmark instead of a 100 percent stock index.
Risk performance analysis
Choose an easy benchmark to create the impression that the portfolio is doing well. This causes investors to draw the wrong lesson and can increase risks in the next cycle.
Changing the start or end date for better results compromises the integrity of the review.
Inappropriate benchmarking makes a portfolio appear better or worse than it actually is.
Choose an easy benchmark to create the impression that the portfolio is doing well. Returns are only meaningful when accompanied by volatility, drawdown, liquidity and targets.
Exercise 1 - reflection
Get portfolio results for the most recent 12 months and analyze them in comparison to benchmarks.
Exercise 2 - case_study
A portfolio of 80 percent stocks and 20 percent bonds should be benchmarked against a corresponding blended benchmark instead of a 100 percent stock index. Identify the correct conclusion, the likely wrong conclusion, and the additional data needed.
Exercise 3 - action_plan
Create a performance review sheet of 5 metrics you will track each quarter.