When reviewing your investment portfolio, you should use an appropriate benchmark to compare performance.
Investment benchmarks should try and mirror your portfolio holdings.
Not the exact individual investments. But the benchmark should reflect the portfolio’s asset classes (and subclasses), investment styles, and the overall risk level of the portfolio. It should also match your target asset allocation.
Using publicly available indices as benchmarks is a simple, but effective, way of achieving this goal.
Index Benchmarks
Index benchmarks are suitable for any type of portfolio.
There are numerous indices available for probably every variation of asset classes and subclasses. Per the Index Industry Association, there were approximately 3.7 million indices offered in 2018. You should easily find one or more indices that come close to reflecting your portfolio composition. This facilitates better apples to apples comparisons.
Index performance data is often calculated daily, so it is easy to determine comparatives.
Find Indices That Match Your Portfolio
With the wide variety of indices, find ones that best match your assets.
For example, a general U.S. equity portfolio might be quite similar in composition and risk to the Standard & Poor’s (S&P) 500 index. However, a portfolio heavily invested in Japan might be better off using the Nikkei 225 as a benchmark. And if you have a global bank-centric portfolio, the Dow Jones Banks Titans 30 Index might be the most relevant.
The same thought process applies to fixed income. Government bonds may have different risk-return profiles than corporate bonds. Risk and return may also vary between countries. Junk bonds will have different profiles than AAA rated bonds. And there will be differences between short, medium, and long-term bonds.
J.P. Morgan has a number of bond indices. These include: J.P. Morgan Global Aggregate Bond Index; J.P. Morgan Emerging Market Bond Index; J.P. Morgan Government Bond Index. Again, whether it be through J.P Morgan or another index, you have many options in selecting fixed income indices to meet your needs.
Even for non-core asset classes or investment strategies, you can find ready-made indices. For example, the S&P Dow Jones Indices, include such indices as: S&P Real Assets; DJ Commodities; DJCI Lean Hogs; Dividend Aristocrats; S&P Pan Africa Shariah; S&P 500 Catholic Values: S&P Eurozone Low Volatility; S&P Target Date 2045.
As you can see, with 3.7 million indices out there, you should be able to find those that meet your needs.
You May Need More Than One
Yes, there are indices that cover different investment strategies and multi-asset portfolios. But you may not find one index that completely matches your entire portfolio.
That is not a problem.
Simply create a composite benchmark that reflects your personal asset allocation.
For example, let us take a simple portfolio. Say 5% U.S. dollars, 35% U.S. bonds of various maturities, and 60% global large-capitalized (cap) equities. For the bonds, the S&P U.S. Aggregate Bond Index might be suitable. And for the equities, the S&P Global 100 represents 100 large capitalized companies from around the globe. Or, for a wider scope, the S&P Global 1200 covers about 70% of global market capitalization.
As best you can, compare apples to apples when comparing your portfolio to the benchmark.
If you have a large percentage of Swiss equities, the S&P Global 100 might not be best. Instead, a Swiss Market Index (SMI) may be more appropriate.
You may also want to drill down into your investment style, if it is relevant.
Perhaps your Swiss equities are made up of large-cap companies. Then the basic SMI works well. But if you have invested in small or mid-cap companies, an index of large-cap companies may not be optimal. You may consider using the Swiss Performance Index (SPI) Extra. This index tracks Swiss small and mid-cap equities outside the SMI.
There are a multitude of indices available. Try to find ones that match your asset groupings as closely as possible.
Then Allocate in the Proper Percentage
Finding the best indices is one part of the equation.
Equally important is to match the weightings of your target asset allocation with the relevant benchmark indices.
If Swiss small and mid-cap equities make up 5% of your portfolio, then the SPI Extra should be weighted 5%.
If global large-cap equities account for 60% of your investments, then weight the S&P Global 100 index at 60%.
A fairly simple concept.
Next, some thoughts on benchmark issues in the context of passive investing.
