Definition
A benchmark is a reference standard, usually an index or a blend of indexes, against which the performance and risk of a fund, portfolio or strategy is measured. It provides a yardstick for judging whether results came from skill, risk-taking or simply market movement.
How it works
A suitable benchmark matches the strategy's market, sector, currency and risk profile, and is transparent and published in advance. Performance is compared as excess return, meaning portfolio return minus benchmark return, over the same period and on the same basis, such as total return in the same currency.
Passive funds use a benchmark as the target to follow, and active funds use one as the target to beat. A poorly chosen benchmark can flatter or penalize results, for example by comparing a technology fund with a broad market index, or a portfolio's total return with an index's price return.
Formula / convention
Excess return = Portfolio return − Benchmark return (same period, same basis)
Illustrative example
Illustration with fictional figures: a Hong Kong equity fund returns 9.0% in a year while its benchmark, a fictional large-cap total return index, returns 11.0%, so the excess return is 9.0% − 11.0% = −2.0 percentage points. Compared instead with that index's price return of 7.5%, the apparent excess return becomes +1.5 points, showing how the wrong benchmark basis changes the conclusion.
What to watch for
Choosing a benchmark after seeing the results, or one that is easy to beat, makes performance look better than it was. A benchmark is a yardstick, not a forecast or a target return.