Benchmark Index – Definition

Cite this article as:"Benchmark Index – Definition," in The Business Professor, updated June 9, 2019, last accessed July 5, 2020, https://thebusinessprofessor.com/lesson/benchmark-index-definition/.

Back to: ECONOMICS, FINANCE, & ACCOUNTING

Benchmark Index Definition

A benchmark Index is a group of securities used in measuring the performance of other stocks or securities in the market. The Dow Jones Industrial Average, the S&P 500, or the Russell 2000 are examples of benchmark indexes.

They are standards that measure the performance of mutual funds, stocks, bonds and securities in the stock market. All types of assets classes have distinct but somewhat similar indexes used in evaluating how well or badly assets perform in the market.

A Little More on What is a Benchmark Index

Benchmarks are important in the investment industry, individual investors are able to evaluate the performance of their investment using the benchmarks. Benchmark indexes cover different market types and characteristics. Large cap, mid cap and small cap have different benchmarks.

The two popular benchmark indexes used in the stock market are the S&P 500 and Dow Jones Industrial Average. All types is assets have specific benchmarks, fixed income for example has the following benchmark indexes; Barclays Capital U.S. Aggregate Bond Index, the Barclays Capital U.S. Treasury Bond Index and few others.

Lipper indexes is one of the benchmarks used in mutual funds.

Investment Industry Fund Management

A benchmark is an essential topic for discussion in the investment industry. It is important for portfolio management or fund management in the investment industry. Through benchmark indexes both investors and investment manager measure the performance of a stock, security or asset before investing in it.

There are two strategies involved in benchmark investing, they are passive investment funds and smart beta funds. As many innovations began to arose in the investment market, benchmarks have also been responsive to these innovations. Active managers also actively engage the use of benchmarks is selecting the types of securities to invest in.

Investors gain exposure to benchmarks using the passive investment fund strategy. Generally, benchmark investments give investors the informed capacity to make informed decisions about equities, stocks and securities they want to invest in. Benchmarks incorporate several securities representing the total market to a degree. Investing in each of the indexes is quite difficult, this is why investors use the passive investment funds strategy as a means of getting exposure to a benchmark.

Also, using the passive investment funds help investors detect large, mid and small caps investments. Passive investment funds replicate benchmark indexes, SPDR S&P 500 ETF (SPY) is an example of passive investment fund that relates the S&P 500 Index.

Smart Beta

Smart Beta investment portfolios offer a wide range of advantages in addition to benefits is passive investment funds. Investments in smart beta are selected based on their positions, whether they take long or short positions to obtain alpha in the stock market.

By investing in standard passive funds or investment that take long and short positions in the cap stocks of the market, smart beta strategies enhance returns that investors enjoy. Smart beta investment reduce investment risks, enhance investment diversification and returns for investors.

Market Segment Benchmarks

Market segment benchmarks are strategies used in the investment industry, this segment benchmark afford investors the opportunity to invest in specific market segments. This is the standard benchmark being divided into segments where investors can invest.

Market segments are called sectors. For instance, investors are allowed to invest in individual sectors in the S&P 500 using market segment benchmarks.

Fundamental and Thematic Benchmarks

Generally, investment managers seek to beat the market or outperforming market benchmarks with a bid to enhance much profit. Beating the market is not easily achieved which is why some managers use replication strategy, especially managers that find it difficult to outperform the benchmark.

Oftentimes, there are demands for benchmark exposure, fundamental investing and thematic investing in the market.

Fundamental funds and Thematic benchmark funds are examples of funds that use customized indexes based on replication. The Global X Robotics & Artificial Intelligence Thematic ETF (BOTZ) is an example of a benchmark that uses the replication technique in tracking the Indxx Global Robotics & Artificial Intelligence Thematic Index.

Active Management

Active management refers to the activities of managers in the investment market that revolves around outperforming benchmark through investment decisions that boost performance. Due to the increase in benchmark replication strategies, active management is more challenging. Replication strategies are used in passive management.

Investors also find out difficult to locate active managers as many managers embrace the benchmark replication strategies and this makes beating the benchmark a daunting task.

References for Benchmark Index

Academic Research on Benchmark Index

The benchmark index ETF performance problem, Gastineau, G. L. (2004). Journal of Portfolio Management, 30(2), 96-103.

Total factor productivity growth and endogenous demand: establishing a Benchmark index for the selection of operational performance measures in public bus firms, Hensher, D. A. (1992). Transportation Research Part B: Methodological, 26(6), 435-448.

A refinement to the Sharpe ratio and information ratio, Israelsen, C. L. (2005). Journal of Asset Management, 5(6), 423-427.

Is there a difference? The performance characteristics of SRI equity indices, Schröder, M. (2007). Journal of Business Finance & Accounting, 34(12), 331-348.

Enhanced performance measurement of mutual funds: Running the benchmark index through the hurdles, Costa, B. A., & Jakob, K. (2010).

Benchmark index of risk appetite, Misina, M. (2005).

Are mutual fund managers selecting the right benchmark index?, Costa, B. A., & Jako, K. (2011). Financial Services Review, 20(2).

Dow Jones sustainability group index: A global benchmark for corporate sustainability, Knoepfel, I. (2001). Corporate Environmental Strategy, 8(1), 6-15.

The Cash-secured Put-Write Strategy and Performance of Related Benchmark Indexes, Ungar, J., & Moran, M. T. (2009). Journal of Alternative Investments, 11(4), 43-56.

Performance evaluation and self-designated benchmark indexes in the mutual fund industry, Sensoy, B. A. (2009). Journal of Financial Economics, 92(1), 25-39.

The information ratio, Goodwin, T. H. (1998). Financial Analysts Journal, 54(4), 34-43.

 

Was this article helpful?