Throughout my profession I actually have railed against the nonsense of benchmarking in all its forms. I actually have now given up hope that corporations and investments will ever abandon the practice, so I do not expect this post to alter anything aside from make me feel higher.
So, give me a minute of pampering or come back tomorrow…
I used to be recently talking to a friend about a company we each know thoroughly that has modified significantly in the previous few years. In my opinion, one mistake the organization made was to rent a strategic consulting firm to benchmark the organization against peer corporations.
Unfortunately, this exercise led to the conclusion that the organization needed to be more like its competitors to achieve success. As a result, the organization began cost-cutting and rationalization efforts to extend “efficiency.”
And you already know what? Thanks to those measures, many individuals today consider that what was special about this organization has been lost and are considering not being their customer.
The problem with benchmarking an organization against its competitors is that it is normally the fastest path to mediocrity. Strategy consultants compare corporations with unique cultures and business models to their competitors and advise them to adopt the identical methods and processes which have made their competitors successful prior to now.
But comparing an organization that’s about to alter the world is solely nonsense. In 2001 and 2002, Amazon’s share price fell by about 80 percent. If Jeff Bezos had asked the three big advisors what he should do, they might have told him to change into more like Barnes & Noble.
Name a single company that went from being a loser to a star, and even modified industries, based on the recommendation of strategic consultants…
This brings me to the subject of investing: here, pension fund advisors and other corporations have introduced benchmarking as a central method for assessing the standard of a fund’s performance.
Of course, a fund manager’s performance should be evaluated someway. But why does this must be done against a benchmark set by a selected market index?
When they follow a selected index, fund managers lose their independent considering. A portfolio that deviates too removed from the composition of the benchmark index puts the fund manager’s profession in danger. If the portfolio underperforms an excessive amount of or for too long, the manager is fired. So over time, fund managers spend money on an increasing number of of the identical stocks and change into less and fewer energetic. And that results in herding behavior, especially for the most important stocks in an index. Why? Because fund managers can not afford not to speculate in those stocks.
Ironically, the entire benchmarking trend has change into circular. Benchmarks at the moment are designed to follow other benchmarks as closely as possible. In other words, benchmarks at the moment are in comparison with other benchmarks.
Take the world of environmental, social and governance (ESG) investing, for instance. In theory, ESG investors needs to be guided not only by financial goals but in addition by ESG-specific goals. Their portfolios should due to this fact be very different from a conventional index akin to the MSCI World. In fact, in a super world, ESG investors would allocate their capital otherwise than traditional investors, helping to channel it toward more sustainable causes.
So I went to the web site of a significant exchange-traded fund (ETF) provider and compared the portfolio weights of the businesses in its MSCI World ETF with the weights in its various ESG ETFs. The chart below shows that there is basically no difference between these ETFs, whether or not they are sustainable or not.
Portfolio weights (%) of the most important corporations: Sustainable vs. conventional ETFs
The advantage of it: Investors can easily switch from a traditional benchmark to an ESG benchmark without great fear of performance losses. This helps to encourage institutional investors to take this step.
The downside, nevertheless, is that there may be little difference between traditional and sustainable investments. If every company meets the necessities for inclusion in an ESG benchmark after which has roughly the identical weight there as in a traditional one, what’s the point of the ESG benchmark? Where is the profit for the investor? Why should corporations change their business practices in the event that they may be included in an ESG benchmark anyway with minimal effort and don’t risk losing any of their investors?
Comparing ESG benchmarks to standard benchmarks is like comparing Amazon to other retail corporations. It will destroy Amazon’s growth and switch the corporate into one other Barnes & Noble.
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Photo credit: ©Getty Images / Mike Watson Images
