Benchmarking
Choose a Benchmark That Can Falsify the Claim
A benchmark should challenge the proposed edge, not provide an easy line to beat.
Working definition
A useful benchmark represents the simplest credible explanation for a strategy's return, risk, or implementation claim.
01
One benchmark rarely answers every question
A long-only equity strategy may need a market index for beta, a factor model for style exposure, and a simple ranked portfolio for incremental signal value. An execution strategy may need arrival price, midpoint, and a naive schedule. Each baseline isolates a different part of the claim.
Comparing only with cash can make ordinary market exposure look like alpha. Comparing only with a complex peer can hide whether the proposed method improves on a simple rule.
02
Benchmarks need the same accounting
The candidate and baseline should use compatible calendars, currencies, leverage, costs, rebalance timing, and missing-data rules. If the benchmark gets unrealistic costs or stale membership while the strategy receives careful treatment, the comparison is descriptive theater rather than evidence.
- Economic baseline: the exposure the strategy may be repackaging
- Naive baseline: a simpler rule using the same information
- Implementation baseline: the execution policy being improved
- Capacity baseline: the scale and liquidity opportunity cost
03
A benchmark can reveal a narrower success
Failing to beat a broad index does not automatically make research useless, and beating it does not prove skill. The useful outcome may be that the signal reduces drawdown, diversifies a particular exposure, or adds value only in a defined regime. Good benchmarking makes that narrower claim visible.
Practical takeaways
- Use several baselines when the claim has several components.
- Apply equivalent accounting and cost assumptions.
- Include a simple rule that can expose unnecessary complexity.
- Interpret relative performance in the context of the stated objective.
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