Importance of Benchmark Selection in Performance Evaluation

Hard Performance Evaluation Benchmarking

Imagine you are a portfolio manager evaluating the performance of your equity portfolio, which returned 12% over the last year. To assess whether this return is satisfactory, you decide to compare it to a benchmark index, which returned 8% during the same period. Furthermore, you are considering the importance of the choice of benchmark in performance evaluation. Which of the following statements best highlights the significance of selecting an appropriate benchmark for performance evaluation?

A benchmark that closely matches the investment style of the portfolio will provide a more accurate measure of performance relative to the market.

Any benchmark can be used for performance evaluation, as long as it reflects the average market return.

The benchmark should only be based on past performance of similar portfolios to ensure comparability.

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