The financial markets are ripe with a variety of opportunities, provided the investor knows where to look. That is why constructing the right portfolio with the right choice of investments with respect to risk and returns, is essential to fulfilling your goals. However, as an investor, how do you know whether your portfolio is faring well or not?
To that end, an efficient means of judging the success of your investments would be finding the right benchmark portfolio to compare your portfolio against. There are a wide range of benchmark portfolio examples to choose from in the market, which is why adept professional portfolio managers play an important part in the process. So, what are benchmark portfolios and how are they used to evaluate the performance of a portfolio manager? Here’s all you need to know.
What are Benchmark Portfolios?
In order to understand how benchmark portfolios can benefit your investments, let us first take a look at the question of “what are benchmark portfolios?”. A benchmark capital portfolio is essentially the definite, unmanaged standard around which your investment portfolio is constructed, its risks are managed and the returns are compared.
Since the conditions within a financial market are always changing, it is important to have a clear and specific value to compare your investments against. To that end, benchmark portfolios can give investors a fair perspective on how their investments are doing with respect to the specific and appropriate market segments.
With a benchmark portfolio, you can assess the overall performance of your investments by comparing them against specific standards such as a market index or a set of indexes. These indexes are unmanaged and “passive” in nature while your investment portfolio is actively managed by an investment manager. Therefore, benchmark portfolios are also useful in determining the value that the manager adds to your portfolio.
How do Benchmark Portfolios Work?
Benchmark portfolios are typically set by professional investment managers with the purpose of fulfilling the investment goals of the investor. Capable benchmark portfolio management takes into account important factors such as the investment style of the investor, his or her risk appetite as well as the expected returns from the portfolio.
The process of setting benchmark portfolios requires expertise in the market in order to select the right portfolio, determine the right amount of asset allocation and identify the appropriate benchmarks. Benchmark portfolios can benefit from professional tweaking in the event that there is unexpected activity or unusually high or low volatility in the market. It is also a sign of good benchmark portfolio management when the manager succeeds in managing risk through diversification.
Why Benchmark Portfolios Matter
Now that you are familiar with the benchmark portfolio meaning, let us take a closer look at why it matters and what it tells us about our investments and their management.
The difference between the performance of a person’s investment individual portfolio and its benchmark portfolio is known as tracking error. This tracking error can be positive or negative and is crucial in determining how well your investments have fared in comparison to your benchmark.
When a portfolio manager is successful in his benchmark portfolio management, the tracking error will be positive and the investment portfolio will outperform its benchmark portfolio. On the other hand, when the portfolio management is not up to the mark, the tracking error will be in the negative and the investments will have underperformed.
Therefore, benchmark portfolios are essential in assessing and measuring the skills of a portfolio manager. They give a direct insight into how closely your investments are performing with respect to the standards you set for them. More importantly, they illustrate the value that the investment managers bring to your investments and the overall portfolio.
Conclusion
The question of exactly what are benchmark portfolios can be best explained as the standard against which the risks and returns of your own investments are measured. After all, the success or failure of a portfolio can only be understood with respect to a specific yardstick in the market. To that end, an efficient portfolio manager can bring immense professional value by setting the right benchmark portfolio and actively managing your funds to help you meet your investment goals.
