Benchmarks are used to determine relative performance of portfolios and securities. They are particularly useful in evaluating mutual funds and money managers. Their usefulness doesn’t stop there, however. Credit unions can certainly employ benchmarks to determine how their own investment portfolios are performing. Before a credit union selects a benchmark, it might make sense to quickly review the characteristics associated with good benchmarks.
According to industry experts (1), a valid and effective
benchmark must exhibit the following properties:
- Informed Opinion
- Specified in advance
Adding some context to each property will help explain its inclusion as a characteristic of a good benchmark.
Investable: The option should exist to invest in the benchmark as an alternative to the portfolio under consideration. For example, it is not possible to invest prospectively in the bond fund that will produce top-decile results come year-end, but it is possible to invest in the two-year treasury.
Appropriate: The benchmark’s main characteristics are consistent with those of the portfolio being measured against it. For example, a credit union’s mortgage-backed securities portfolio is compared to a mortgage-backed bond index.
Informed Opinion: The investments in the benchmark and how they perform are understood, so the performance of the portfolio against the benchmark can be explained.
Unambiguous: There is an easy way to ensure against ambiguity for a benchmark—make sure the name and weight of the index or peer group members are clearly defined.
Specified in Advance: The benchmark is selected/constructed prior to comparing portfolio performance. This might seem like common sense but assigning or changing the benchmark after the fact can understate or overstate performance comparisons.
If any of these attributes are missing, it becomes difficult to have confidence that the benchmark provides a valid point of reference for measuring performance.