Index Benchmarks

On 05/09/2011, in Investment Strategies, by Jordan Wilson

A good investment benchmark should try and mirror your portfolio holdings.

Not the exact individual investments.

But the benchmark should reflect the portfolio’s asset classes and subclasses, investment styles, and the risk level of the portfolio. It should also match your intended asset allocation.

Using indices as benchmarks is a simple, but effective, way of achieving this goal. 

Index Benchmarks

Index benchmarks are suitable for any type of portfolio.

There are numerous indices available for probably every variation of asset classes and subclasses. You should easily find one or more indices that come close to reflecting your portfolio composition. This facilitates better apples to apples comparisons.

Index performance data is often calculated daily, so it is easy to determine comparatives.

Find Indices That Match Your Portfolio

With the wide variety of indices, find ones that best match your assets.

For example, a general U.S. equity portfolio might be quite similar in composition and risk to the Standard & Poor’s (S&P) 500 index. However, a portfolio heavily invested in Japan might be better off using the Nikkei 225 as a benchmark. And if you have a bank-centric portfolio, the Dow Jones Banks Titans 30 Index might be the most relevant.

The same thought process may apply to fixed income. Government bonds may have different risk-return profiles than corporate bonds. Risk and return may also vary between countries. Junk bonds will have different profiles than AAA rated bonds. And there will be differences between short, medium, and long-term bonds.

J.P. Morgan has a number of bond indices. These include: J.P. Morgan Global Aggregate Bond Index; J.P. Morgan Emerging Market Bond Index; J.P. Morgan Government Bond Index.

You May Need More Than One

It may be rare to find one index that completely matches your entire portfolio.

Most investors do not have portfolios that mirror any one benchmark. At least those individuals that have some diversification in their assets.

But that is not a problem.

Simply create a composite benchmark that reflects your personal asset allocation.

For example, let us take a simple portfolio. Say 5% U.S. dollars, 35% U.S. bonds of various maturities, and 60% global large-capitalized (cap) equities. For the bonds, the Dow Jones CBOT Treasury Index might be suitable. And for the equities, the S&P Global 100 represents 100 large capitalized companies from around the globe.

As best you can, compare apples to apples when comparing your portfolio to the benchmark.

If you have a large percentage of Swiss equities, the S&P Global 100 might not be best. Instead, a Swiss Market Index (SMI) may be more appropriate.

You may also want to drill down into your investment style, if it is relevant.

Perhaps your Swiss equities are made up of large-cap companies. Then the basic SMI works well. But if you have invested in small or mid-cap companies, an index of large-cap companies may not be optimal. You may consider using the Swiss Performance Index (SPI) Extra. This index tracks Swiss small and mid-cap equities outside the SMI.

There are a multitude of indices available. Try to find ones that match your asset groupings as closely as possible.

Then Allocate in the Proper Percentage

Finding the best indices is one part of the equation.

Equally important is to match the weightings of your target asset allocation with the relevant benchmark indices.

If Swiss small and mid-cap equities make up 5% of your portfolio, then the SPI Extra should be weighted 5%.

If global large-cap equities account for 60% of your investments, then weight the S&P Global 100 index at 60%.

A fairly simple concept.

Next, some thoughts on benchmark issues in the context of passive investing.


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