Relevant Benchmarks
A benchmark is a standard against which portfolio performance is measured. Benchmarks answer a simple question: "How did this portfolio do compared to what it should have done?"
Choosing the right benchmark matters. The wrong benchmark can make a mediocre manager look brilliant or a skilled manager look terrible.
Common Equity Benchmarks
| Benchmark | What It Covers | Weighting |
|---|---|---|
| S&P 500 | 500 large-cap US stocks | Market-cap weighted |
| Russell 2000 | 2,000 small-cap US stocks | Market-cap weighted |
| Wilshire 5000 | Total US equity market | Market-cap weighted |
| MSCI EAFE | Developed international markets (ex-US, ex-Canada) | Market-cap weighted |
| NASDAQ Composite | All NASDAQ-listed stocks | Market-cap weighted |
| Dow Jones Industrial Average (DJIA) | 30 large-cap US stocks | Price-weighted |
| Consumer Price Index (CPI) | Inflation | N/A (used for real return comparison) |
Key points:
- Market-cap weighted means larger companies have more influence on the index's return
- Price-weighted means higher-priced stocks have more influence, regardless of company size
- The Wilshire 5000 is the broadest US equity benchmark, often used as a proxy for the total US stock market
- The MSCI EAFE excludes the US and Canada, making it the standard international developed-market benchmark
- The CPI is used as a benchmark for comparing real (inflation-adjusted) returns
Exam Tip: Gotchas
- The DJIA is price-weighted, NOT market-cap weighted. The S&P 500 is market-cap weighted. If the exam asks which index uses price weighting, the answer is the Dow Jones Industrial Average.
Common Fixed-Income Benchmarks
- Bloomberg U.S. Aggregate Bond Index ("the Agg"): covers the broad investment-grade US bond market. This is the standard fixed-income benchmark.
Index Weighting Methods
| Method | How It Works | Example |
|---|---|---|
| Market-cap weighted | Larger companies have more influence | S&P 500, MSCI EAFE |
| Price-weighted | Higher-priced stocks have more influence | DJIA |
| Equal-weighted | All components weighted equally | S&P 500 Equal Weight Index |
Benchmark Selection Principles
The benchmark must match the portfolio's investment style, asset class, and risk profile. Using an inappropriate benchmark is misleading and overstates or understates manager performance.
- A small-cap portfolio should be measured against the Russell 2000, not the S&P 500
- An international equity fund should be measured against MSCI EAFE, not a domestic index
- A bond portfolio should be measured against the Bloomberg Aggregate, not an equity index
Exam Tip: Gotchas
- The exam will test whether you can select the appropriate benchmark for a given portfolio. A manager of a small-cap value fund should NOT be compared to the S&P 500 (large-cap blend). Always match the benchmark to the portfolio's style and asset class.