"Nothing in life is as important as you think it is, while you are thinking about it.” Daniel Kahneman, Thinking, Fast and Slow
One of the most important decisions that an investor makes is the choice of benchmark used to represent the investment outcome that they are seeking to achieve. For passive investors, the link is direct. With a wide range of exchange traded funds and other tracking funds, it is possible to construct a portfolio that closely reflects the desired benchmark less costs. For active investors using the services of a discretionary investment manager, the benchmark
is typically used to inform the process of setting investment guidelines and serves as both a “neutral” asset allocation and a performance target. The manager then seeks to deliver performance over and above the benchmark through a combination of tactical asset allocation and superior fund/stock selection.
In behavioural science, the “anchoring bias” refers to the tendency to rely too heavily on the first piece of information offered. Benchmarks can act as a powerful anchor, constraining both the expectations of the client and the actions taken by a discretionary investment manager. This article examines the potential impact.