Definition of benchmark

A point of reference that is used to compare investment performance. It forms an objective test of the effective implementation of an investment strategy.  Benchmarks allow returns and variations in investment returns to be measured and attributed, thereby making it possible to determine how effectively investors have performed against them.  Well chosen, benchmarks allow returns to be decomposed at every level.  They allow the users of the resultant analysis to communicate effectively and to make informed decisions.

Broad market indices are the most common type of benchmark.  Examples include the FTSE All Share index and the FTSE 100.  That said, there are many other types of benchmark including custom security related (normal portfolios), absolute, factor model based, manager universe, returns based and style based variants.  There is also a genre of alternative benchmarks designed to benchmark against the liabilities of an institution. 

A fund manager typically manages to a benchmark to pursue an active or a passive investment strategy. It can also be used for identifying and measuring risk exposures, appraising fund managers, measuring consistency, facilitating clear instructions, the presentation of investment results in marketing and sales and meeting regulatory requirements. [1]