Benchmarking the results of an investment manager is a basic form of accountability that helps to determine whether the manager is really adding value with their investment process. For which the evolution in recent decades of ever-more-finely-sliced benchmarks – from the Morningstar Style Box to factor regression analysis – applies an ever-increasing focus on determining exactly which managers are really adding value, and which are simply benefitting from the underlying results of a well-performing asset class (or factor) they happened to already own.
Of course, benchmarking has a dark side as well. For underperforming managers, it can literally cause them to be fired – arguably for a justified reason of underperformance, but an outcome that incentivizes at least some managers (including some financial advisors who manage portfolios) to become closet indexers… while others are always in search of alternative “benchmarks” that are less prone to (potentially) unfavorable outcomes in the first place.
In this context, a recent “innovation” suggested by some advisors and managers is to benchmark results relative to the investor’s (financial planning) goals in the first place, rather than the manager’s comparable benchmark. After all, the whole purpose of the portfolio is (usually) not merely to grow for the sake of growing, but to grow for the purpose of achieving a goal. Which means, arguably, the real focus should be on the investor’s progress towards their goals, not their (potentially short term) performance relative to some investment benchmark.
Yet in practice, benchmarking investment managers and financial advisors to goals may simply give them “credit” for favorable results that were really nothing more than the market delivering whatever the market was going to return – which is beyond the control of the manager anyway. And in a world where most financial projections are done with a straight-line return assumption, benchmarking to goals can actually quickly become the equivalent of a (relatively high) absolute return benchmark that is even more likely to lead to disappointing results that makes the manager look even worse (at least in the short term when the next inevitable bear market occurs).
More generally, though, the key is to recognize that even though investors should care about their investment results relative to a goal, the process of evaluating an advisor or manager and the value they do (or don’t) add to the process still needs a proper investment benchmark. In other words, there’s a difference between benchmarking the investor’s results to their goals (driven by the markets) and benchmarking the advisor’s or manager’s results (driven by their own investment decisions). And while benchmarking relative to goals may be appropriate to measure the former, it is still not an appropriate way to evaluate the latter!
source https://www.kitces.com/blog/problem-benchmarking-to-goals-investor-vs-advisor-performance-results/?utm_source=rss&utm_medium=rss&utm_campaign=problem-benchmarking-to-goals-investor-vs-advisor-performance-results
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