Less than half of nonprofits polled in the Study On Nonprofit Investing (SONI) indicated that they have a formal portfolio benchmark, which identifies their portfolio’s performance expectation, outlined in their Investment Policy Statement. We believe that appropriate benchmarks are needed for organizations to be able to quickly and easily evaluate the value of both their investment adviser and the funds included in the portfolio. It is RWM’s philosophy that benchmarks should clearly communicate the return expectation based on market conditions.
There are five main reasons why creating a formal portfolio benchmark helps boards evaluate their advisers:
- Provides context for performance results
- Establishes a “control” performance expectation based on market conditions and organization’s risk tolerance (target mix of stocks/bonds)
- Reflects the absence of professional judgement, therefore enabling the value of professional judgement to become clear
- Removes emotion from decision-making, allowing for objective evaluation of an adviser or investment committee
- Makes oversight straightforward, allowing boards to focus on strategic planning
We recommend instituting three levels of benchmarking:
- For the overall portfolio: We recommend comparing the portfolio performance to a custom benchmark that matches the target asset allocation outlined in an Investment Policy Statement (IPS). When compared to a portfolio’s net of fees performance, this benchmark allows a Board to identify whether or not their adviser’s asset allocation and fund selection added value. The benchmark should also be outlined in the IPS and remain constant unless the actual target asset allocation in the IPS has changed.
- For each distinct asset class: We recommend establishing distinct, neutral, asset class benchmarks. A few examples follow:
- Total U.S. Stock Market – Russell 3000 Index
- International Stock – MSCI All Country World Index FTSE ALL World Ex US Index
- Intermediate-Term Bond Market – BBG US Aggregate Bond Index
- Short-Term Bond Market – BBG 1-5 Yr Gov Bond Index
- Each fund or separately managed account that underlies each asset class: You can drill down further to the fund level comparing each distinct investment to a style and size specific benchmark – such as the MSCI International Small Cap Index to measure the results of an international small-cap fund. This provides supplemental information to the overall portfolio benchmark and asset class benchmarks, allowing you to make an objective evaluation.
By using these three benchmarking levels, your organization will easily be able to evaluate the portfolio’s performance and fulfill the oversight role.