Performance Perspectives Blog

Benchmarks: what can / can’t you do?

by | Nov 8, 2016

Benchmarks & the world of ignorance

It appears that there is a tremendous amount of misunderstanding within our industry regarding what firms can or cannot do with market index-based benchmarks. At the core, many investment professionals, including asset managers and asset owners, don’t understand that they are proprietary to the market index provider, and that provider gets to set the rules.

If benchmarks are regularly available, surely they’re free!

One somewhat common belief is that since we can easily find market index data in newspapers or on line, or hear them quoted on television or the radio, they must be free. Right? Well, no, they’re not.

In order to use market index-based benchmarks, you have to have a license. And, that license will dictate how you can use them. E.g., to use internally or to put on client reports.

What might some of the restrictions be?

Many firms want to adjust their market indexes or blend them together to create custom benchmarks. Can they?

Some market index providers restrict firms from modifying their indexes; e.g., to remove a country, sector, or even company from the index. There may also be limitations on the blending of market indexes (e.g., to have 60% of your large cap growth index blended with 40% of your bond index). It’s important to review your license agreements to learn what you are able to do.

But what can the index providers do if we “cross the line”?

We recently heard that at least one index provider periodically conducts audits, where they will visit a firm to discover how their indexes are being used. And, we understand that in at least one case, the firm was charged a substantial fee because they had not stayed within the covenants of the license.

But to have the vendor create custom benchmarks can be quite expensive!

Yes, that’s true, it can be. And so, if you want to have an “ex-” version of an index, you have to decide if the cost is worth it. Some custodians now pass these costs along to their clients, because they’ve grown quite a bit.

An alternative would be to find a comparable index provider who charges less, and there are a few.

If I switch market index providers, can I continue to show the history of the old index?

Answer: maybe yes, maybe no. What does your license agreement say?

You don’t “own” the index data: you’re licensing it. Meaning, that if you discontinue the relationship, chances are you will no longer to show the data, even though you did historically.

But the index providers are so different, how can we switch to a lower cost one?

ACTUALLY, there’s evidence that market index providers aren’t all that different. The Journal of Performance Measurement® published an article earlier this year: “Are all market indexes created equal?” It’s based on research we did, along with BNY Mellon, Northern Trust, and State Street.

This essentially means that you may have alternatives that could save you money, and provide you with greater flexibility. Worth considering, we think!

Bottom line: there probably are some restrictions in what you’re permitted to do; therefore, it’s worth reviewing your license agreements to make sure you’re staying within these restrictions.

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