Podcast Center
Video Center
Webcasts
Resource Center
Events
September 27, 2024 at 03:31 PM
What You Need to Know
- The use of sophisticated investment strategies and asset classes like derivatives and private credit makes benchmarking more complicated.
- The SEC's marketing rule sets benchmarking standards for when firms advertise performance.
- Investment professionals need to conduct cost-benefit analyses of the benchmarks they are using or considering.
With the introduction of increasingly sophisticated investment strategies and asset classes like derivatives and private credit, benchmarking costs have risen in recent years. Indeed, as markets have grown in size and complexity, so have the costs of using benchmarks, such as stock indexes or private peer group data, for comparing performance against broader market activity.
Regulators such as the Securities and Exchange Commission have established requirements and general prohibitions for firms marketing performance, including the use of performance benchmarks.
For instance, Rule 206(4)-1 of the Investment Advisers Act of 1940 (the “Marketing Rule”) stipulates that when registrants advertise performance, benchmark comparisons must be clear, relevant and include all context.
Regulators and compliance teams want to ensure that registrants exercise fiduciary prudence when choosing and disclosing benchmarks or that they publish relevant market conditions when no meaningful benchmark is available, such as for less liquid assets or highly complex strategies.
Investment professionals must be savvy and selective to implement benchmarks that are relevant to their investment strategies, but affordable as well. Many are finding more costly subscription options for benchmark data they used to get on demand for free or at a fraction of the cost.
While regulators do not stipulate the specific benchmarks registrants should use, performance presentations must not be misleading and must be fair and balanced. Cherry-picking benchmarks that put performance in the most favorable but not necessarily representative light is not going to pass the general prohibitions test. Getting the best fitting benchmark — especially for private markets — can incur additional challenges and costs that using a commonly known market indicator may not.
Presenting custom benchmarks can create additional benchmark integrity, but also increases disclosure challenges. For example, an accounting system may be incorrectly pulling in a similarly named benchmark constituent along with several others, resulting in a custom return that appears reasonable but is inaccurate. Each constituent in the custom benchmark must be disclosed, and that often leads to multiple subscription payments for a single benchmark.
Dynamic benchmarks that can monitor manager over/under-performance while staying within prescribed allocation constraints have all the challenges of custom blends and more. The need to dynamically adjust benchmark weights as a firm’s allocations changes increases the operational and compliance complexities. Moreover, full disclosure of investment-specific benchmark allocations runs the risk of disclosing information that might tip off competitors to the underlying strategy.
Many opt to disclose market conditions in lieu of benchmarks and, per the investment performance services (ISP) agreement, keep custom benchmarks for internal and client use only.
