What is a benchmark and how does benchmarking work?

A benchmark is a reference point or index against which the financial performance of an investment portfolio, asset, or strategy is compared. The purpose of a benchmark is to objectively evaluate the effectiveness of asset management by identifying whether the strategy’s return exceeds that of a comparable market indicator, adjusted for risk.

Benchmarking is the process of comparing the performance and other characteristics of an investment portfolio with a corresponding benchmark.

You can see the comparison in:

the charts in Overview → Portfolio change
the diagram in Analysis → Portfolio profitability
the ratios: Beta, Sharpe ratio, Sortino ratio in Analysis → Risks

For the purpose of calculating benchmark returns, virtual transactions are used to simulate the structure of the actual portfolio. On each asset purchase date in the portfolio, a virtual purchase of the benchmark is made for an equivalent amount (quantity based on the benchmark price on the asset purchase date). Similarly, when an asset is sold, a virtual sale of the benchmark is made at the benchmark price on the sale date, and the quantity is determined by the ratio of asset quantity to benchmark quantity on the entry date. This allows for an accurate comparison of the portfolio and benchmark performance under identical cash flow conditions.

If the strategy demonstrates higher returns at a comparable or lower level of risk than the benchmark, it indicates its effectiveness.

Note: In order for the comparison to be representative, the benchmark should cover the same market, asset class, and investment style.