In the investing world, benchmarks are essential tools for a number of reasons. They provide a clear reference point for evaluating performance, guiding long-term asset allocation, asset managers, and framing discussions about risk and return and anchor expectations. But while benchmarks offer structure, they should not be mistaken for the sole definition of success. Comparing a real-world portfolio too rigidly against a benchmark can often miss the bigger picture.
The CFA Institute has published an insightful article titled ”Escaping the Benchmark Trap: A Guide for Smarter Investing”, addressing a growing concern in institutional investment practices. With insights drawn from real-world portfolio behavior and industry trends, the article challenges the overreliance on benchmarks as definitive measures of success. It highlights how rigid comparisons to indices can distort strategic decisions, especially when those indices don’t reflect the investor’s actual constraints, goals, or risk profile. This publication serves as a valuable reference for asset managers, pension funds, and fiduciaries looking to align performance evaluation frameworks with more meaningful, client-centric outcomes.
Benchmarks Are Not Real Portfolios
Benchmarks are simplified representations of market performance. They typically represent broad market indices composed of securities weighted by market capitalization. They assume ideal conditions: fully invested positions, no transaction fees, no liquidity needs, no regulatory constraints, and no cash drag. Actual portfolios, however, must operate under very different circumstances. They are shaped by specific client objectives, liability structures, regulatory requirements, governance policies, and sometimes a phased implementation timeline.
This distinction is critical. Consider a pension fund still in the process of deploying its strategic allocation. In this phase, the fund may hold a higher proportion of cash or defensive assets and a lower exposure to growth assets such as equities. Now imagine that, during the same period, equity markets generate strong returns. The benchmark—fully exposed to those growth assets—would naturally outperform. But this doesn't mean the portfolio has failed. Rather, it reflects a prudent approach, where liquidity preservation and risk control were rightly prioritized during a transitional phase. Importantly, this kind of conservative positioning may underperform in bullish markets — but it can serve the portfolio well in the opposite scenario. In periods of market stress or downturns, these same deviations from the benchmark may help cushion losses.
Real-World Portfolios Face Real-World Pressures
Beyond strategic positioning, there are also operational realities that benchmarks simply do not reflect. For example, an unexpected inflow of contributions may require time to be deployed into target investments, temporarily resulting in a higher cash balance and lower returns. Conversely, an extraordinary outflow—such as a large benefit payment or capital withdrawal—may force early liquidation of growth assets, impacting performance.
Liquidity constraints can also limit how quickly a portfolio can rebalance. Certain asset classes, particularly in private markets or infrastructure, are not as readily tradable as benchmark constituents might suggest. Furthermore, fiduciaries may adopt a more defensive posture in anticipation of upcoming liabilities or market uncertainty—decisions made in the best interest of the investor, even if they create temporary deviations from benchmark returns.
Intentional Differences Are Not Necessarily Mistakes
In many cases, deviating from a benchmark is a strategic choice. A portfolio may deliberately be underweight in certain sectors or asset classes, or it may incorporate ESG (Environmental, Social, and Governance) screens that exclude high-return but ethically misaligned industries such as fossil fuels, tobacco, or weapons. While these choices may lead to tracking error, especially if the excluded sectors are temporarily outperforming, they represent intentional alignment with client values — not performance failure.
It’s also worth emphasizing that benchmarks do not reflect any of the frictions involved in real investing. There are no management fees, trading costs, taxes, or delays in execution. A benchmark assumes an idealized investment universe; real portfolios operate in a far more complex environment.
Rethinking What Success Looks Like
This is why performance evaluation must go beyond the simplistic question: “Did we beat the benchmark?” A more robust and informed approach should ask:
- Is the portfolio aligned with the client’s objectives and constraints?
- Are risks — market, liquidity, operational — being effectively managed?
- Are returns being delivered efficiently given the current realities?
- How are strategic decisions (e.g., ESG integration, implementation pacing, liquidity planning) shaping performance?
At C.Y. Actuaries, we encourage clients to treat benchmarks as a compass — not a finish line. They provide useful directional guidance, but they do not define success on their own. Market benchmarks are just one method of assessing performance. While they can be effective over short-term periods, especially for tactical evaluation, they may fall short when it comes to long-term institutional investing. For institutional clients such as provident funds, insurance companies, or organizations with long-term investment objectives, success is more meaningfully measured against broader benchmarks, such as keeping pace with inflation, meeting retirement outcome needs, or achieving pre-determined targets. Real success lies in building and managing a portfolio that is fit for purpose, resilient under stress, and tailored to the investor’s goals and risk capacity, even if that sometimes means trailing a benchmark that doesn’t fully reflect the portfolio’s real-world constraints and strategic intent of our portfolio.
Need support with designing an appropriate investment strategy? Contact us today to find out how we can help.
Styliana Sampson
Associate Consultant at C.Y Actuaries
The views expressed above are solely of the author and do not necessarily represent the view of Cronje & Yiannas Actuaries and Consultants Ltd
