Benchmark portfolio
A reference portfolio, typically an index, matched in composition to a client's own portfolio so the client's actual returns can be fairly compared against it, comparing 'apple with apple'.
In plain language
An investor's return means little on its own — 12% for the year sounds good until you know what similar investments earned over the same period. A benchmark portfolio solves this by giving a fair comparison point.
It has to match the client's own portfolio in composition. The workbook's own rule of thumb is to compare 'apple with apple' — a portfolio invested in large-cap equities should be measured against a large-cap index, not a small-cap or a debt index.
How it works
For a large-cap equity portfolio, the workbook gives BSE 30 or NIFTY 50 as suitable benchmarks. For a long-term bond portfolio, an appropriate benchmark is a bond index with a similar maturity and credit profile to the portfolio being measured.
Some portfolios need more than one benchmark at once, a hybrid or multiple benchmark, where different slices of a mixed portfolio are compared to different indices, or a blended benchmark reflects a stable asset allocation mix across the whole portfolio. A benchmark, once chosen, is not fixed forever: it should be reviewed regularly, and replaced if the nature of the investment portfolio changes, or if the benchmark's own composition changes.
A worked example
A client's portfolio is invested 70% in large-cap equity and 30% in long-term government bonds. Using a single benchmark for the whole portfolio, such as only NIFTY 50, would be misleading — it ignores the debt portion entirely.
Instead, the adviser builds a hybrid benchmark: 70% weight to the NIFTY 50 index and 30% weight to a long-term government bond index. If the client's portfolio returns 11% for the year, and the hybrid benchmark, 70% of a NIFTY 50 return of 13% plus 30% of a bond index return of 7%, works out to 10.6%, the client's portfolio has beaten its true, like-for-like benchmark by 0.4 percentage points — a comparison a single equity-only benchmark could never have given fairly.
Why NISM asks about it
Chapter 15 (Portfolio Construction Process), section 15.13, 'Benchmarking the client's portfolio', names BSE 30 and NIFTY 50 as large-cap benchmarks and sets out the selection criteria in section 15.13.1. Expect a question that gives a portfolio's asset mix and asks you to pick, or build, the appropriate benchmark for it.
Common exam traps
- A wrong benchmark can make a good manager look bad, or a poor manager look good — the workbook stresses that selection of the benchmark is as important as the performance number itself.
- A benchmark should be easily investible and replicable; one with dramatically changing composition, or with limited data availability, such as an unavailable Total Return Index, weakens the comparison.
- Do not benchmark a mixed portfolio against a single-asset-class index — use a hybrid or blended benchmark that reflects the actual allocation.
Check yourself
1.What is the guiding idea behind selecting a benchmark for a client portfolio?
- a)To choose the index with the lowest historical return so that outperformance is easier
- b)To compare apple with apple, using a benchmark portfolio that matches the composition of the investor's portfolio
- c)To use the Nifty 50 for all portfolios so that comparison is standardised
- d)To change the benchmark each year to reflect the best performing index
Show the answer
Answer: (b) To compare apple with apple, using a benchmark portfolio that matches the composition of the investor's portfolio
The IPS will typically include a benchmark portfolio which matches in composition the investor's portfolio, and the idea is to compare "apple with apple". A large cap portfolio must be compared with a large cap index and a mid cap portfolio with a mid cap index, because a wrong selection can paint a completely different picture which could lead to wrong investment decisions.
Where this is taught
Free preparation for NISM Series X-ARelated terms
- Portfolio managerA body corporate registered with SEBI that, under a contract with a client, advises on or manages that client's securities or funds — discretionary, non-discretionary or advisory.
- Allocation effectIn performance attribution, the part of a portfolio's return over its benchmark from over- or under-weighting a sector versus the benchmark, separate from the return earned by picking securities.
- Net selectivityFama's absolute performance measure: the fund's return above the risk-free rate, less the market premium the portfolio's own total risk would have earned on its own.
- Portfolio management processThe repeating sequence of planning, execution and evaluation through which an adviser creates an optimum portfolio for a client and then keeps it optimum as things change.
- SelectivityThe fund manager's ability to select securities that generate extra returns — the stock-picking half of performance attribution, as against timing the market or weighting a sector.
- Cash drag adjusted returnA portfolio return recalculated to include cash the manager has not yet deployed, correcting for the fact that idle cash earns less than the main investment and drags overall performance down.
- Fixed costIn a Portfolio Management Service, the charge the investor pays regardless of performance — usually a set percentage of assets managed, plus brokerage — as against the separate performance-linked fee.