Effective investment benchmarking provides added information to determine as early as possible when corrective action is necessary.
While market indexes are valuable components of the performance evaluation process, used alone they are insufficient. Simple index comparisons lack the context required to draw meaningful conclusions.
Because indexes provide only a single comparative data point for each time period, it takes decades* to determine with any statistical meaning whether or not an investment manager has skill (positive or negative). So by the time you have enough data to reach a conclusion, it’s far too late.
Put another way, when your manager underperforms his benchmark index, you cannot know whether or not that degree of underperformance is enough to justify taking action.
Peer universes complement indexes by providing vital additional context.
Imagine hearing that your child scored 650 out of 800 on the SAT. Is that good news or bad? Without the additional context of SAT percentile rankings (better yet, the distribution for admitted students of schools of interest) you cannot begin to assess your child’s results.
Benchmarking against indexes provides the raw score. Adding peer universes provides the context necessary to interpret that score.
* FARQUHAR, T., ROSENBERG, B. and RUDD, A. (1982), Factor-Related and Specific Returns of Common Stocks: Serial Correlation and Market Inefficiency. The Journal of Finance