Why Benchmark Choice May Be The Most Strategic Investment Decision

Pension plans are facing a moment they would rather avoid. Both the Financial Times and Wall Street Journal have chastised plans for weak 2024 private equity returns. Behind the numbers is a quieter story about how returns are measured.

Performance benchmarks are supposed to measure progress, evaluate performance, and guide strategy. But these actions depend on questions about how benchmarks are selected, governed, and constructed. Who decides what they are and why? How do you adjust a benchmark so it fits your fund’s needs? And what is the logic of a plan that tracks different benchmarks for private equity, private credit, and real estate?

CEM Benchmarking tackles these issues. Using 30 years of data from roughly 300 defined benefit pension plans, we observe three insights: funds tend to adjust their benchmarks in one of three distinct ways, most private market measurement lacks a unified “house view,” and concentration risk in public equity benchmarks is often overlooked.

1. The Three Benchmark Archetypes

We looked at how pension plans adjust strategic asset allocation  benchmarks based on factors such as strategy, leverage, sector, region, currency, interest rate sensitivity, risk, and inflation. These adjustments fall into one of three approaches, each shaped by a fund’s philosophy. Instead of tailoring approaches by asset class, funds usually lean on a single archetype to tell their performance story. None of the three methods is inherently better than the others; each reflects a different view of how performance should be shown.

Benchmark Engineers: These funds build their portfolios into their benchmarks.

Engineers design benchmarks to match the portfolio, building metrics that reflect how it earns returns rather than tracking an unadjusted market index. They take a systematic approach, adjusting for strategy, region, and currency, alongside sector-specific calibrations. Macro factors such as leverage, interest rates, risk, or inflation may also be built in. This level of customization is applied across a fund’s asset class benchmarks. For example, an engineer might benchmark the fund’s private equity allocation as: 40% S&P 500 (USD/EUR hedged), 90-day lag, +2% per annum; 25% Stoxx Europe 600 (hedged), 90-day lag, +2% per annum; 10% MSCI AC Asia ex-Japan (hedged), 90-day lag, +2% per annum; and 25% fixed 7% per annum.

Benchmark Tailors: These funds adjust benchmarks for select criteria, often tied to specific exposures, views, or operational preferences.

Tailors make targeted adjustments tied to specific exposures or views, most often by region or strategy. Macro changes are limited or uneven, and the extent of adjustments can differ from one asset class to another within the same fund. For example, a tailor might set a private equity benchmark at 67% S&P 500 + 33% MSCI Europe + 3% per annum.

Benchmark Minimalists: These funds keep benchmarks simple, relying on standard indices with little customization to highlight value add.

Minimalists rely on broad market indices, making few, if any, adjustments. This precision approach to benchmarks does not mean the minimalist investment approach is simplistic. Instead, benchmarks may be designed to represent the total investable universe. Any differences between a minimalist’s benchmarks and their actual portfolio are treated as active investment decisions. For example, a minimalist private equity benchmark might be the MSCI World Small Cap Index, used not as a strategy proxy but as a reference point for evaluating active management.

It is tempting to assume that larger funds naturally gravitate toward more complex benchmarks. In practice, benchmark design reflects philosophy as much as size. For some, this means adopting the engineer model, where benchmarks are built to mirror portfolio risk factors. The intention is clear: align benchmarks more closely with how the fund earns returns. But complexity brings its own problems.

Stakeholders often prefer results shown against simple, investable indexes rather than detailed constructions. And when too much of the portfolio design is embedded in the benchmark, it becomes harder to measure whether that design has worked. For this reason, funds that once pursued complexity often find themselves returning to minimalist benchmarks.

2. The Limited Prevalence of House Views

Private market benchmarks rarely follow a single playbook. Analyzing roughly 300 funds from the 2023 CEM Investment Benchmarking Services database, public market proxies dominate in private equity and private credit, peer-based private benchmarks lead in listed real estate, and inflation-based measures top listed infrastructure. The variety raises the question of whether these choices reflect a single, coordinated strategy or are they made asset class by asset class?

A helpful way to think about the question is by asking whether a fund follows a “house view” on benchmarking. A house view is a unified philosophy on performance measurement. It means applying the same methodology, such as one benchmark type, across all private market asset classes. A fund with a house view might use public market proxies for private equity, private credit, listed real estate, and listed infrastructure without exception, ensuring the performance story is told consistently across the portfolio.

Situational benchmarking takes a different path. Here, each asset class has its own benchmark, chosen on its terms. While this approach offers flexibility, it can make it harder to assess the portfolio when benchmarks are not investable.

Our review of more than 1,000 benchmark–asset class combinations shows that situational benchmarking is far more common than a house view in private markets. Most funds switch benchmark types from one asset class to another.

3. Concentration Risk

When only a handful of companies drive market returns, benchmarks inherit the same imbalance. In 2024, more than half of the S&P 500’s earnings growth came from just seven stocks. Indices that lean too heavily on a handful of firms can skew both performance and risk in ways that may have little to do with a fund’s actual strategy.

Constrained benchmarks address concentration risk by capping the maximum weight of any single company or by equalizing weights across constituents. Nevertheless, 81% of public equity benchmarks in the CEM Universe follow standard market-cap weightings without any constraints.

The picture looks different in some Canadian markets. Smaller and mid-sized Canadian funds are more likely to use constrained benchmarks when compared to the broader CEM Universe. These funds often use the S&P/TSX Capped Composite Index. The preference for capping may reflect a lesson from Canada’s past. Nortel’s collapse in the early 2000s, after it had grown to represent more than a third of the S&P/TSX Composite Index, showed the dangers of concentration risk.

Advance Performance Benchmarking Research

Benchmarks quietly shape investment decisions. We continue to examine how funds establish primary and secondary benchmarks, govern them, and approach benchmark construction. We also look at how flexible allocations are benchmarked, including absolute return mandates and tactical asset allocation

Andrew Kaufman is a senior research associate at CEM Benchmarking and holds a PhD from the University of Toronto. His work blends academic-level analysis with a deep interest in how institutions make financial decisions.

Christopher Doll joined CEM in 2023 and leads client coverage in the U.S. market, bringing over 20 years of asset management experience in client relations, product management, development, and marketing. Passionate about improving the lives of retirees, he has launched multiple asset managers, helped build the Canadian ETF business for a multinational firm, and is a frequent industry speaker. He can be reached at Chrisd@cembenchmarking.com

This feature is to provide general information only, does not constitute legal or tax advice, and cannot be used or substituted for legal or tax advice. Any opinions of the author do not necessarily reflect the stance of ISS STOXX or its affiliates.

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