Benchmark Index

For a Fund, the Benchmark Index defines the investment universe, the risks and potential returns. For a stock it becomes a reference for performance measurement.

In preparing to invest in the Stock Market, identifying and setting an appropriate Benchmark Index is critical in defining the investment universe, the risks and potential returns. There are many, many indexes. A Benchmark Index, could be either a broad market index, a market capitalisation index, for example Small Cap Stocks, or a sector index, Financial Stocks. The critical issue is that it is the Index referred to when investing or measuring the relative performance of either a fund or a stock.

For an index to be considered appropriate for the purpose of benchmarking, it must contain the stock being referred to or in the case of a fund, a large portion of a fund’s holdings must be taken from the Benchmark index’s constituents. The less representative of a fund’s holdings to the Benchmark Index, the wider the Tracking Error. The Benchmark Index chosen in order to measure a Fund’s performance must not be swapped for another index. If the Benchmark Index changes, then this could change the characteristics of the Fund.