What Makes a Good Benchmark?

Whether you are managing a Fund or just a personal portfolio, selecting the right benchmark could be important as you seek to evaluate your own performance. Below are the core characteristics to look for in a benchmark.

For the sake of example, I add a little personal comment on how I feel the S&P 500 works as a benchmark to Berkshire Hathaway stock returns given that they use it as their guide.

• Appropriate (A) 

the benchmark needs to be appropriate. you can't use a basket of US large cap insurance stocks to track performance of an african insurance stock. here it is a question whether S&P 500 with a sizable weighting in technology is appropriate for BRK which is a collection of companies with relatively little technology exposure. It kind of feels that S&P 500 does not fit well here

• Investable (I)

S&P 500 does well here. You can simply use a low cost ETF such as the Vanguard VOO

• Measurable (M)

S&P 500 stock returns are openly available and in terms of being measurable there clearly is no argument here

• Accountability (A)

warren buffet did say that his managers are incentivized to outperform the S&P 500 and he himself as put his reputation on the line in order to succeed in this task. certainly these guys "own" their benchmark

• Representative of the Investor's Views (R)

this one is more difficult. Berkshire Hathaway is clearly focused on high quality large cap value as a style of investing and research suggests that this style does closely match the BRK performance. it is therefore difficult to take S&P 500 - a broad index of US firms as representative of the BRK style of investing and approach. BRK also has some investments abroad which is also a factor to consider

• Unambiguous (U)

the S&P 500 stocks are closely followed and rarely do companies get kicked out or included in the index. certainly it does not feel ambiguous 

• Set Out in Advance (S)

Warren Buffet has set out S&P 500 as the benchmark many many years ago. if I'm not mistaken from the outset. It certainly seems like the benchmark clears this hurdle