Everyone knows what makes a good benchmark - right? From time to time, an organisation announces it has built “a better benchmark” or “a better index.” Claims such as these are usually supported by simulated historical index performance, insinuating that performance should be considered in the benchmark selection process.
Market participants can be confused by these types of claims and consequently overlook important elements of index design and construction that can vary widely - even among indices that target identical market segments.
Our objective here is to shed some light on this issue. First, we list the important role a benchmark plays throughout the entire investment process. Then, we discuss three core principles of benchmark construction - principles that have guided the design and management of the Russell US Indexes for nearly 40 years.
Finally, we touch on the inevitable trade-offs index providers must consider during the application of these principles in order to provide effective representation.
