Benchmarks are fundamental tools for investors to evaluate the results of their portfolios versus the broad performance of representative asset classes. However, financial advisors continue to combat the media-driven focus on the S&P 500 Index, which is rarely representative of an investment portfolio. This is particularly evident when considering diverse portfolios that include asset classes not represented in the S&P 500, such as fixed-income securities. Even all-equity portfolios seldom look like the S&P 500. Recognizing this gap, advisors should consider blended benchmarks to provide a more accurate assessment of portfolio performance and better align with client goals.
Blended benchmarks, which combine multiple indices or asset classes, offer a tailored approach to performance evaluation that reflects the unique objectives and risk tolerance of each client. For example, a portfolio diversified across equities, fixed income, and alternatives may benefit from a blended benchmark that includes relevant indices for each asset class. This approach provides a more representative view of performance and ensures that the benchmark more accurately captures the contributions of all investments within the portfolio.
Investors with significant exposure to international markets will find benchmarks like the MSCI EAFE Index or the FTSE Developed ex North America Index to be more relevant than the S&P 500. Similarly, investors with fixed-income-focused portfolios may benefit from benchmarks such as the Bloomberg US Aggregate Bond Index, which better represent the performance of fixed income securities.
Here's why advisors should consider adopting blended benchmarks and how they can benefit their clients:
- Improving Communication: Using benchmarks that accurately reflect the composition of the portfolio enhances communication between advisors and clients. Clients can better understand how their investments are performing relative to relevant benchmarks, fostering trust and transparency in the advisory relationship.
- Enhancing Risk Management: Blended benchmarks enable advisors to better assess and manage portfolio risk. By incorporating indices that represent different asset classes and regions, advisors and investors gain a more comprehensive understanding of portfolio risk exposures to make more informed decisions to mitigate risk.
- Aligning with Client Objectives: Tailoring benchmarks to align with client objectives ensures that performance evaluation is meaningful and relevant. By selecting benchmarks that closely mirror the client's investment strategy, advisors can provide a more personalized approach to portfolio management.
- Adapting to Market Dynamics: Blended benchmarks offer flexibility to adapt to changing market conditions and evolving client needs. Advisors can adjust benchmark compositions as needed to reflect material portfolio changes or shifts in client priorities, ensuring that benchmarks remain relevant and effective over time.
- Reflecting Portfolio Diversity: Blended benchmarks offer a more accurate representation of portfolio performance by incorporating relevant indices for each asset class. This ensures that performance evaluation reflects the full spectrum of investments within the portfolio, providing a comprehensive view for both advisors and clients.
Obtaining More Appropriate Benchmarks
Advisors can leverage various resources and tools to identify benchmarks that closely align with the client's portfolio composition and objectives. Several data sources and index providers offer a diverse range of benchmarks covering different asset classes and regions. Providers such as Bloomberg, MSCI, FTSE Russell, and Nasdaq deliver access to a wide array of indices beyond the S&P 500, allowing advisors to select benchmarks that better represent the client's investment universe. Additionally, turnkey asset management platforms such as Freedom Advisors can offer valuable insights and tailored solutions for identifying more appropriate benchmarks.
By leveraging these resources, advisors can ensure that benchmarks accurately reflect the client's investment strategy and provide a meaningful basis for performance evaluation. Regular monitoring and adjustment of benchmarks based on changing market conditions and client objectives further enhance the effectiveness of the portfolio management process.
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