Benchmarks – Why, How, and Which to Use?
Last Updated: August 19, 2015
|Index Benchmark||Peer Group Benchmark||Custom Benchmark|
|This is a group of securities that represent a certain segment of the market (asset class). Returns are calculated by averaging the returns of securities within the index and weighting them based on market capitalization||This calculates the average performance of investment managers within different asset classes. In essence, is an investment manager beating the average investment manager (top 50%). Common forms of peer group benchmarks include Morningstar Categories and Lipper Averages.||When an investment manager cannot find a standard benchmark to represent the current investment set, a custom benchmark commonly used in asset classes that are a mixture of several asset classes (ie. balanced, allocation, or target date). The benchmark consists of combining 2 or more benchmarks.|
- The Russell index is comprised by weighting all U.S. stocks from largest to smallest capitalization. The largest 1,000 stocks constitute the Large Cap asset class and the smallest 2,000 constitute the Small Cap asset class. The determination between value or growth is more complex, but ultimately utilizes metrics like book-to-price ratio, earnings per share (EPS), Return on Assets (ROA), and debt-to-equity.1
- The CRSP ranks all U.S. stocks by market cap as well but does not limit the index to 3,000 stocks. Instead it sets breakpoints and bands. For example, the Large Cap represents the top 85%, Small Cap the bottom 2%, and Mid Cap representing the remaining. The growth or value metrics used include price-to-book, forward and trailing earnings/price, dividend yield, and sales/price. CRSP keeps 100% of each stock in its respective style index until it passes through a buffer zone. At that point, CRSP moves 50% from one style index to the other. The remaining half will be transferred at a later date.2