The Right Benchmark is the Bedrock of Strong Active Management

Active management is a difficult game. If it wasn’t, you wouldn’t want to pay much for it. If you do decide to pay up for active management, you want to be able to ascertain that you are receiving real benefit.

Part and parcel of considering active management are the notions of “outperformance”, “value-add” and “excess return”. These concepts inherently refer to a return that is relative to something – a benchmark. Unless we are clear in our minds that the benchmark is a strong point of reference by which to compare the fund manager’s efforts, we are not able to tell whether active management has actually been worthwhile.

When identifying a suitable sector benchmark for a manager (at least for traditional asset classes, we can generally say that a benchmark:

1. Should reflect the investable universe in the sector,
2. Should be indicative of the characteristics of the actual portfolio on average over the longer term, and
3. Could be expected to resemble the portfolio positioning an active manager might “default” to if it had few high conviction ideas at any given time.