Benchmarking Has Become Circular | CFA Institute Enterprising Investor

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Throughout my career I have repeatedly told about crap in all forms of benchmarking. So far I’ve given up hope that trading and investing will ever overtake practice, so I don’t expect this post to change anything other than make me feel better.

So, indulge me for a minute or come back tomorrow. . .

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I recently spoke with a friend about an organization that we are both well acquainted with and that has changed a lot over the years. In my view, the organization made a mistake that it hired a strategic consulting firm to benchmark the organization to its peers.

Alas, the result of that exercise was the determination that the organization must be like its peers in order to be successful. As a result, the organization has engaged in cost-cutting and streamlined exercises in an effort to increase “efficiency”.

And guess what? Thanks to those measures, many people now think that what made that organization special is lost and are no longer thinking about not having customers.

The problem with benchmarking a company against its competitors is that it’s the fastest way to measurable. Strategy consultants compare companies with unique cultures and business models to their peers and ask them to adopt the same methods and processes that have made their peers successful in the past.

But benchmarking a company that is changing the world is utter foolishness. In 2001 and 2002, Amazon’s stock price declined by 80% or so. If Jeff Bezos had asked the Big Three consultants what they should do, they would have told them to be like Barnes & Noble.

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Name a single company, which turned from loser to star performer or even transformed its industry based on the advice of strategic advisors. . .

Or as Howard Marx, CFA, puts it so bluntly: “You can’t do the same thing that others do and expect to perform better.”

Which brings me to investing, where pension fund advisors and other companies have introduced benchmarking as a key method for assessing the quality of a fund’s performance.

Of course, the performance of the fund manager must be evaluated somehow. But why should it be against a benchmark set by a specific market index?

When they are benchmarked against a specific index, fund managers stop to think independently. A portfolio that deviates too far from the structure of the reference benchmark, poses career risk for the fund manager. If the portfolio underperforms for too long or too long, the manager is fired. So over time, fund managers invest more and less in a single stock and become less active. And this in particular makes hers among the largest stocks in the index. Why? Because fund managers can no longer take the risk of not investing in these stocks.

The irony is that the entire trend of benchmarking has become circular. Benchmarks are now designed to track other benchmarks as closely as possible. In other words, benchmarks are now benchmarked against other benchmarks.

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Take for example the world of environmental, social and governance (ESG) investing. Theoretically, ESG investors should be motivated not only by financial goals but also by ESG-specific goals. Therefore their portfolio should look materially different from traditional indexes such as MSCI World. In fact, in an ideal world, ESG investors would allocate capital differently than traditional investors and thus help put capital to more sustainable use.

So, I went to the website of a major exchange-traded-fund (ETF) provider and compared the portfolio weightings of companies in the MSCI World ETF with the weightings in its various ESG ETFs. The chart below shows that there is essentially no difference between these ETFs, sustainable or not.


Largest Corporate Portfolio Weighting (%): Continuing vs. Traditional ETFs

Chart, bar chart details automatically generated
Source: Bloomberg

The good thing about this is that investors can easily switch from the traditional benchmark to the ESG benchmark without worrying much about losing performance. This helps in persuading institutional investors for the move.

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But the downside is that there is little difference between traditional and sustainable investing. If each company qualifies to be included in the ESG benchmark and then that benchmark has the same weight as the traditional, what is the point of the ESG benchmark? Where is the profit for the investor? Why should companies change their business practices when they will somehow be included in the ESG benchmark with minimal effort and not risk losing any of their investors?

Benchmarking against traditional benchmarks The ESG benchmark is like benchmarking Amazon against other retail companies. It would kill Amazon’s growth and turn it into another Barnes & Noble.

For more on Joachim Clement, CFA, don’t miss 7 Mistakes Every Investor Makes (And How To Avoid Them), And Risk Profiling and Tolerance, and sign up for CLIMATE ON INVESTMENT Vaccination.

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All posts are the views of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of the CFA Institute or the author’s employer.

Image Credits: © Getty Images / Mike Watson Images


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Joachim Clement, CFA

Joachim Clement, CFA, is the trustee of CFA Institute Research Foundation and provides regular commentary CLIMATE ON INVESTMENT. Prior to this, he was CIO at Wellershoff & Partners Ltd., and prior to that, Head of the UBS Wealth Management Strategic Research Team and Head of Equity Strategy for UBS Wealth Management. Clement studied mathematics and physics at the Swiss Federal Institute of Technology (ETH), Zurich, Switzerland and Madrid, Spain, and graduated with a master’s degree in mathematics. In addition, he has a master’s degree in economics and finance.



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