What are a benchmarks in finance?

Investors must periodically analyse how their portfolio is performing, by assessing the return earned and the risk experienced.

Professional managers expect to be judged against some objective standards for comparison. These standards are known as Benchmarks.

How are benchmark portfolios used?

The most useful way to construct a benchmark is to define a Benchmark Portfolio.

Benchmark portfolios may be defined for special purposes, or based on standard products.

Note that the Active Weight for a given portfolio in any asset can then be defined as:
Active weight = Portfolio weight - Benchmark weight
How do you construct a benchmark portfolio?

Benchmark portfolios should be constructed in order to create a view of performance which is consistent with the market or sector which is being described. The outcome is usually called an Index.

Many companies specialise in creation of investment indices e.g. MSCI, FTSE, Dow Jones etc.

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