I always try and have some investment-related theme in my posts. For those of you who read these expecting that investment idea and despair when I ramble on about something completely random, today fear not! This is definitely investment related.
The concept of investment benchmarks has always puzzled me. I remember starting out as a green investment consultant and learning about benchmarks from my colleagues. My background was law and most of my colleagues were trainee actuaries with maths degrees. When I challenged the logic of benchmarks, my objections would often be met with a strange look, a sigh and a lengthy explanation of the need to have a reference that is investible, transparent, independent, etc. etc. I would usually retreat to my corner with the heavy feeling that I ought to shut up and bow to the accepted wisdom.
Almost 30 years later and I still have an uneasy feeling about investment benchmarks. I do feel somewhat justified in my early questioning, however, as I have since listened to many learned people dismissing the reliance on benchmarks and read many articles supporting my scepticism – although all offering a basis for their views, rather than my gut feel! Indeed, the industry does seem to have bifurcated to on one side investment approaches that are ‘unconstrained’ and largely free of benchmarks (from the perspective of portfolio construction, not measurement) to – on the other side – exposures that completely mimic the benchmark in index funds.
Notwithstanding this transition to a better use of benchmarks, I still wonder if we are focused on the wrong thing. This is not a new issue and there have been many papers published on the short comings of the different approaches used. Market capitalisation is naturally biased towards the winners (sectors and stocks) – fine whilst times are good, although bubble forming, but less good when markets are heading south. The trend in recent years has been to diversify the broad market cap approach with systematic factor exposures: value, small cap, momentum, dividend yield, quality. Although this is starting to look more at the underlying characteristics of the companies, the categorisations remain a blunt proxy for measuring the success or otherwise of a portfolio. Although, to be fair the use of these tends to be more for index investment rather than benchmark comparator.
The catalyst for my re-thinking of the benchmark debate was actually not at the aggregate level but rather when we drill down to the sectors. I attended a webinar for an investment fund that looks at technology developments across all companies and sectors. In other words, rather than focus on those tech heavy sectors they look across the entire investment universe to identify companies that are changing and adapting business models to make best use of technologies. Within their investment approach they actually reclassify the Global Industry Classification Standard (GICS) into their own defined sectors and construct an index from their own definitions rather than relying on the industry standard. They do, however, compare the performance of their funds against the standard global equity benchmark.
With the growing interest in ESG criteria for investing, I wonder whether we will see the growth of similar approaches to the dissection of industry classifications; each trying to pare down a company to features to offer like for like comparisons with other organisations. Hopefully there will be more thinking in this space and challenge to the conventional thinking – particularly when it comes to portfolio decisions being driven by concern over deviating too far from the benchmark at a stock, sector or even country level.
