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Are portfolio benchmarks still important to clients?

Are portfolio benchmarks still important to clients?

‘To benchmark or not to benchmark?’ That is the question. Some advisers would answer that, as long as clients’ financial objectives are met, whether or not the investments outperformed or underperformed a benchmark is of little consequence. Client needs have been fulfilled, which is all that matters. Benchmarks can go hang.

As you like it

‘The idea we can somehow dispense with benchmarks is very in vogue now,’ said passive investment campaigner Robin Powell. ‘This is especially so among active fund managers and with advisers advocating active management.’

So can we really dispense with them? Not according to Powell. He does not even think it is acceptable for advisers to use an internal benchmark that is not shared with the client.

‘The evidence shows investors are best served by investing for the very long term in a highly diversified portfolio of low-cost index funds and rebalancing every year or so,’ he said. Powell added that, if an adviser suggests a different strategy, the client must be able to see how well or badly they are doing compared with the evidence-based approach. ‘Transparency demands it,’ Powell said.

Gill Cardy, a former financial planner, agrees. ‘Clients know what the FTSE 100 does every day. Everyone who follows news knows what happens to stock markets. So you need to answer the question of how things do against other things.’

The better part of valour

Cardy said benchmarking was not just about assessing investment performance; it also concerns our psychological make-up. ‘I’ve had clients who have looked at each other’s valuations and asked: how did he or she end up with more money than me? It’s human.’

Indeed Abraham Okusanya, director of research consultants Finalytiq, points to section 6.1.6-R of the Conduct of Business Sourcebook from the Financial Conduct Authority (FCA). This says:

‘A firm that manages investments for a client must establish an appropriate method of evaluation and comparison such as a meaningful benchmark, based on the investment objectives of the client and the types of designated investments included in the client portfolio, so as to enable the client to assess the firm’s performance.’

Okusanya pointed out this section of the sourcebook refers to discretionary portfolios. But he added: ‘That’s beside the point. There’s an expectation the FCA will consider it good practice to benchmark portfolios against an index whether advisory or discretionary.’

Much ado about nothing?

So what should advisers use as benchmarks? Okusanya said choosing benchmarks was ‘tricky’. He suggests using the MSCI World Index for equity allocation, and the Bloomberg Barclays Global-Aggregate index for bond allocation.

‘The benchmark should be the global market as the starting point,’ he said. ‘Global capital markets have the ultimate diversification available to any “ignorant” investor. If, on a risk-adjusted basis, your allocation does better than global capital markets, then you’ve added value through your own genius. If it doesn’t, then you haven’t.’

But Matthew Walne, director of Loughborough-based Santorini Financial Planning, does not believe in the need for benchmarking. During client reviews, he benchmarks against what clients need rather than against market performance.

‘Being on track is the most important thing for clients,’ Walne said. ‘Outperforming markets is not always that relevant to what we are doing.’

However, Walne pointed out most of his firm’s funds are inexpensive passive index funds that are likely to perform in line with markets anyway. ‘So, in a sense, we are already benchmarked,’ he said.

He added: ‘If you go down the active route, then you probably need to be more conscious of benchmarks. But you are potentially causing more problems for yourself.’

The answer, then, appears to be ‘to benchmark’, irrespective of whether you adopt an active or a passive approach. You could say we need a ‘measure for measure’.

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