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Benchmarking has become circular CFA Institute Enterprise Investor


Over and over again throughout my career I have talked nonsense about benchmarking in all its forms. So far I’ve given up hope that business and investment will ever put practice behind me, so I don’t hope this post will make me feel better.

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

I recently talked to a friend about an organization with which we are both intimately acquainted and it has changed considerably over the last few years. In my view, one of the mistakes of the organization was to hire a strategic consulting firm that would identify the organization with its peers.

Alas, the result of that practice was the determination that the organization must be like its peers to be successful. As a result, the company engages in cost reduction and well-organized practice in an effort to increase “efficiency”.

And guess what? Thanks to these arrangements, many now feel that what made that company special is lost and they no longer think of being its customer.

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

But the benchmarking of a company that is going to change the world is complete nonsense. In 2001 and 2002, Amazon’s share price was 80% or less. If Jeff Bezos had asked the Big Three consultants what he should do, they would have told him to be like Barnes & Noble.

Capitalism tiles for everyone

Name a single company that goes from losing to becoming a star actor or changing its industry based on the advice of strategic advisors. . .

Or as Howard Marx, the CFA, put it so bluntly: “You can’t do the same thing as others and do more than expected.”

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

Of course, the performance of the fund manager needs to be evaluated somehow. But why should it be against a criterion set by a certain market index?

When they are benchmarked against a certain index, fund managers stop thinking independently. A portfolio that goes far beyond the structure of the reference benchmark creates career risks for the fund manager. If the portfolio works too little or too little for too long, the manager is fired. So over time, fund managers invest more and more in the same stocks and become less and less active. And it makes cattle, especially in the largest stocks on an index. Why? Because fund managers can no longer afford to invest in these stocks.

Ironically, the whole benchmarking trend has become round. Benchmarks are now designed to track other benchmarks as closely as possible. In other words, benchmarks are now benchmarked against other benchmarks.

Tile for geopolitics

Take, for example, the world of environmental, social and governance (ESG) investment. Theoretically, ESG investors should be guided by ESG-specific goals, not just financial goals. So their portfolios should be materially different from a traditional endowment index like MSCI World. Indeed, in an ideal world, ESG investors would allocate capital differently than traditional traditional investors and thus help capital use more sustainably.

So, I went to the website of a major Exchange-Traded-Fund (ETF) provider and compared the company’s portfolio weight of its MSCI World ETF with the weight of its various ESG ETFs. The chart below shows that there is basically no difference between these ETFs, sustainable or not.


Largest company portfolio weight (%): Sustainable vs. conventional ETFs

Charts, bar chart descriptions are created automatically
Source: Bloomberg

The good thing about this is that investors can easily switch from a conventional benchmark to an ESG benchmark without too much worry about losing performance. It helps to persuade institutional investors to take this step.

Financial Analyst Journal Current Issue Tile

But the downside is that there is little difference between traditional and sustainable investments. If each company qualifies for inclusion in an ESG benchmark and then that benchmark weighs roughly the same as a conventional one, what does the ESG benchmark mean? Where are the benefits for the investor? Why do companies have to change their business practices when they are included in an ESG benchmark with minimal effort and do not risk losing any of their investors?

Benchmarking ESG benchmarks as opposed to conventional benchmarks is like benchmarking Amazon against other retail companies. It will kill Amazon’s growth and turn it into another Burns & Noble.

Be sure to learn more from Joachim Clement, CFA 7 Mistakes Every Investor Makes (And How To Avoid Them), And Risk profiling and tolerance, And sign up for it Clement on investment Comment

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All posts are the author’s opinion. As such, they should not be construed as investment advice, or the opinions expressed must not reflect the views of the CFA Institute or the author’s employer.

Photo Credit: © Getty Images / Mike Watson Image


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Joachim Clement, CFA

CFA Joachim Clement, a trustee of the CFA Institute Research Foundation and provides regular commentary here Clement on investment. Previously, he was the CIO of Wellarshof & Partners Limited, and before that, the head of the UBS Wealth Management Strategic Research Team and the Head of Equity Strategy at UBS Wealth Management. Clement studied mathematics and physics at the Swiss Federal Institute of Technology (ETH), Zurich, Switzerland and Madrid, Spain, and earned a master’s degree in mathematics. In addition, he holds a master’s degree in economics and economics.



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