Benchmarking and budgeting

PORTFOLIO CONSTRUCTION | MODULE 2

Continue the portfolio construction course with module 2, which outlines the first two steps of the portfolio construction process: 1) Benchmarking 2) Budgeting 3) Investing and 4) Monitoring.

Benchmarking involves establishing a standard as a point of reference to measure portfolio performance against, which can help to better compare and evaluate asset allocation.

Benchmarking should be the first step in creating a stable portfolio

Take the first step in building an investment portfolio by creating a benchmark.

It serves as a tool for financial professionals to monitor the progress of investments, including projecting what returns their clients can expect to receive at the start of any time period and evaluating returns at the end of a set time period.

All investors should use a benchmark to manage portfolios often and early in the process

However, financial professionals tend to leave out the benchmark when constructing or making changes to a portfolio, and use it only at the end of their asset allocation process to evaluate a portfolio’s performance.* By using the benchmark at the end of the process, opportunities to pivot and optimize the portfolio throughout the process are forfeited.

3 action items to get started

Start with a broad strategy

Begin by considering investments from the broadest perspective, evaluating stocks vs. bonds.

Then, narrow in on specific products and timeframes

What assets or asset classes should the performance of this portfolio be measured against?

Lastly, define your timeframe

What timeframe is appropriate — the next five years, the next full market cycle or the entire investment horizon?

Pick a benchmark that is the best fit

There are different types of benchmarks that help measure success and can be selected based on the investment approach.

The budget phase requires considering how to efficiently manage two types of budgets – cost and risk. All financial professionals should set a multi-tiered budget before investing.

Budget types

Cost budget

Minimize the cost of fees and taxes to maximize the value of the portfolio.

Risk budget

Set the suitable level of risk based on the objectives discussed during the benchmark phase. Consider how much risk and what types of risk a client is willing to take.

Reduce costs by combining index, factor and alpha-seeking strategies

Blending complementary sources of return and pairing factor strategies alongside index and alpha-seeking (or active) strategies is one way of reducing costs while helping to improve investment outcomes. Explore the differences between the strategies.

Index strategies	Factor strategies	Alpha-seeking strategies
Seek to provide low-cost, diversified market exposure and can serve as the anchor for core portfolio exposures.	Seek to provide incremental returns by targeting historically broad and persistent sources of return such as value, momentum and quality.	Seek incremental returns by targeting unique and harder to access insights.
No excess returns, unless through successful market timing.	Potentially meaningful excess returns.	Potentially meaningful excess returns and differentiated from factor returns.
Lowest fees	Low to moderate fees	Moderate to high fees

Index strategies

Seek to provide low-cost, diversified market exposure and can serve as the anchor for core portfolio exposures.

No excess returns, unless through successful market timing.

Lowest fees

Factor strategies

Seek to provide incremental returns by targeting historically broad and persistent sources of return such as value, momentum and quality.

Potentially meaningful excess returns.

Low to moderate fees

Alpha-seeking strategies

Seek incremental returns by targeting unique and harder to access insights.

Potentially meaningful excess returns and differentiated from factor returns.

Moderate to high fees

Blending index, factor and alpha strategies

For illustrative purposes only

Index strategies may provide a well-diversified, low-cost anchor for portfolios.

Consider tilting toward more factors for clients seeking to deliver on differentiated returns at a lower cost.

Consider tilting toward more alpha-seeking for clients seeking higher risk-adjusted return or more opportunistic portfolios.

Index strategies may provide a well-diversified, low-cost anchor for portfolios.

Consider tilting toward more factors for clients seeking to deliver on differentiated returns at a lower cost.

Consider tilting toward more alpha-seeking for clients seeking higher risk-adjusted return or more opportunistic portfolios.

This is David.

As a nurse, David makes an impact by ensuring the ongoing health of all of his patients.

Investment portfolios need personalized care from dedicated professionals, too.

When building a portfolio, financial professionals should start by defining their clients’ goals. With those in mind, there are a number of strategies financial professionals can employ to ensure the portfolio is healthy and on track to meet their clients’ goals.

Indexing, for instance, is a strategic method that provides diversified market exposure at a low cost. Consider this strategy to serve as the core of a portfolio.

For higher returns, look to factor and alpha-seeking strategies. Factors, on one hand, offer the potential for excess return at a generally lower cost than alpha-seeking.

But while alpha-seeking typically has higher fees, it offers greater potential for excess and differentiated returns.

At the end of the day, it is all about finding a balance between the strategies.

Investors seeking higher excess returns, for instance, might lean more into factor and alpha-seeking strategies, while those who are seeking lower-cost investments and are comfortable with lower excess returns might use a higher proportion of index vehicles.

When pursuing a well-balanced portfolio, it is crucial to ensure that these strategies are properly blended. The overlap of alpha-seeking strategies, for example, could lead to a less diversified portfolio that may earn lower-than-expected returns.

David knows that sometimes, it takes a combination of strategies to get the right results.

Similarly, BlackRock helps financial professionals find a healthy balance between index, factor, and alpha-seeking strategies.

Think differently

Financial professionals who establish a benchmark and reference it regularly provide their clients with transparency into how successfully they are meeting objectives or identify where they may need to pivot. Further, creating a budget and exploring how to best combine different investment strategies to minimize cost can optimize the value of the portfolio.

This concludes the second module of the portfolio construction course. Read the next module, which discusses the last two steps of the portfolio construction process, to continue the course.

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Benchmarking and budgeting

What is benchmarking?

Benchmarking should be the first step in creating a stable portfolio

All investors should use a benchmark to manage portfolios often and early in the process

3 action items to get started

Pick a benchmark that is the best fit

What does budgeting entail?

Budget types

Reduce costs by combining index, factor and alpha-seeking strategies

View transcript

Think differently

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