New Coke

In April of 1985, the world was introduced to New Coke.  A corporate faux pas that would go down in history as one of the greatest marketing flops of all time; a what-not-to-do case study taught in business schools across the country.  

As the tale is told, the Coca-Cola leadership team was nervous about losing market share to competitors.  This anxiety was amplified by the PepsiCo marketing campaign – The Pepsi Challenge, a blind taste test that concluded consumers preferred Pepsi to Coke.  The powers at be at Coca-Cola wanted to innovate, and they wanted to give the customer what Coca-Cola thought they wanted – New Coke, a sweeter flavor, a more Pepsi-like beverage.   

It was no more than three months later that the company, Coca-Cola, reintroduced their classic flavor re-branding it with the “Coca-Cola Classic” moniker.   

This soft drink story is the perfect example of the collateral damage caused by misleading benchmarks.  Today we will talk about how benchmarking in investing can sometimes lead to similar woes.   



The Birth of Benchmarking

In 1924, the world was introduced to the first [modern] mutual fund.  A way for investors to gain diversified exposure to the stock market is by purchasing a single fund.  An innovation that seems both obvious and simple now but was truly revolutionary at the time.  Today there are nearly 8,000 mutual funds ranging across different asset classes, strategies, cost structures, etc. 

As the industry matured from one mutual fund to many, a whole universe of metrics and measuring tools was birthed in the evolution process.  Mutual fund fact cards became like baseball cards – a flashy graphic accompanied by a plethora of key statistics.  The baseball geeks of finance started to use most of the Greek alphabet – everything from alpha to beta – to quantify different portfolio performance metrics.   

This standardization process is normal and needed for a maturing industry.  A codifying or taxonomy of the space helps provide clarity to the participants, creating a common language to compare and contrast strategies.   

Bad Incentives

BUT as Peter Drucker, the famed father of management stated, “[only] what gets measured, gets managed.”  These mutual fund metrics evolved from a diagnostics tool to targets to be achieved and managed to.  One of these common metrics is tracking error, a mathematical representation of how different an investment behaves (the up and down movements of its price) from an index or its benchmark.  A strategy that has zero tracking error would basically mimic the performance and volatility path of an index.   

Let me remind you that mutual Fund managers are people.  People with careers, families, and bills to pay.  Over time these portfolio metrics have become tools of assessment and there was, and is, heavy pressure from leadership and investors to achieve top-tier metrics on a consistent basis.  Like the ruthless fans of New York sports teams, there is very little grace for an underperforming pitcher in the Big Apple or an underperforming manager in the mutual fund landscape.    

The realities of career risk and tracking error (looking different than the benchmark) shaped an entire industry and generation of managers.  A herd was formed, and uniqueness and contrarian viewpoints were often ostracized as opposed to celebrated.   

Bad Press

First, the birth of the mutual fund, next a growing population of metric chasing copycat fund managers, and then come the critics.  As mutual funds continued to grow and collect healthy fees for their management services, the financial media began to criticize the “average” results.  The narrative sounded something like this: If in aggregate, the mutual funds look the same or similar (low tracking error) to the benchmark, yet charge a premium for their services, then a passive approach at a lower cost should create a superior result.  It is not rocket science, if two outcomes are the same and one costs more, then you want the same outcome at the lower cost.   

Again, the fear of your career being on the line, an industry that has pressured you into looking like your benchmark, and a high-fee culture will invite critics AND rightfully so.      

The Lost Decade

Now, here’s the problem, what if the benchmark isn’t the right measuring stick for YOUR portfolio.  What if YOUR portfolio has a greater calling, what if the need and call of YOUR portfolio is to fulfill YOUR financial plan.  Is your financial plan concerned with someone else’s career risk anxieties? Or should your portfolio be handcuffed to an index with an expectation of lockstep results? 

The decade following the tech bubble in 2000 is often referred to as the Lost Decade.  A 10-year stint – a decade – in which the S&P 500 compounded at a negative rate.  An S&P 500 investor in the early 2000’s had less money than they started with 10 years later.  The Nasdaq carried this streak even longer, stretching nearly 15 years in the negative territory.   

These are not short time periods, and these extended seasons of paltry performance can be detrimental to one’s financial plan.  So, if traditional benchmarks can be dangerous, just as they were for the Coca-Cola company, how should a prudent investor go about benchmarking their portfolio results?   

  1. A Needs-Based Benchmark 
    The first and most important benchmark should be based on your specific needs.  You should have a financial plan drafted that has an expected rate of return that is needed for your financial plan to pencil; the results needed to meet all your financial objectives.  Creating better investment results than your neighbor or an index is worthless if those results don’t help you achieve your personal financial goals.  Coca-Cola’s obsession with PepsiCo was a distraction from their team learning how to better serve their own customer base – distracted by competitive tactics they lost sight of their customer.     
  2. An Expectation-Based Benchmark 
    When you invest you have an expectation.  Those expectations should be declared and discussed.  Your financial professional NEEDS to know those expectations to assure they are (1) realistic/achievable and that (2) your timeline for measuring those results is reasonable.  If you are expecting high double-digit returns for a one-year investment, that needs to be realistic, reasonable and agreed upon between you and your advisor.  So much disappointment in investing comes from unrealistic expectations and a lack of communication around those expectations.  
  3. A Substitute-Based Benchmark
    If you’ve created your needs-based benchmark, and set your expectation-based benchmark, I think it is allowable to have one additional measuring stick.  Because there is going to be a tendency to always measure your results vs. something that yielded a better result, you should set a substitute investment option from the start.  One substitute strategy that you would have invested in if you didn’t choose the strategy you employed.  This is not a group of strategies or a revolving door of strategies, this is one alternate.  This is strictly to fulfill your “what if” appetite and protect yourself from comparing your results to something you would’ve never considered investing in.  Basic economics teaches us about substitutes and trade-offs, so I am encouraging you to choose one alternative as another option to benchmark your chosen strategy.  As the Berkshire Gurus – Buffett and Munger – often state, “It’s not greed that drives the world, but envy.”  Your substitute-based benchmark puts your envy on a leash and limits your comparison to only one fantasy alternative reality.   

Take The Good With The Bad

Here’s the reality, whatever investment strategy you choose, if you stick with it long enough, you are going to experience seasons of bliss and seasons of frustration.  Strategies come in and out of favor relative to one another.  You should do thorough diligence around a strategy that you believe has robust research to support it, a logical basis for its philosophy, and that is fitting to your financial plan, then you need to STICK WITH IT.  There is an old quip in finance, “A portfolio is like a bar of soap. The more you touch it, the smaller it gets.”  The more you chase past performance, fiddle with your strategy, pivot, change, adjust, re-adjust, and so on, the worse your results often become.  This is not an advocation for a set and forget it, there will also be some level of tinkering and improving on the margin, but the core philosophy should have some tenure.   

If I Only Had A Time Machine…

One of my favorite movies, or set of movies, is the Back to the Future series.  One scene that always distinctly sticks out to me is when Marty is traveling back in time and Biff Tannen secretly swipes his sports almanac.  This little pamphlet rich with sports “history” is actually the “future” sports outcomes that Biff is yet to live through.  Like any ambitious entrepreneur with the answers to the test, Biff uses this almanac to bet on every major sporting event, and with 100% accuracy, Biff accumulates unimaginable wealth for himself, leading our time traveling friend Marty to an alternate reality (future).   

Just imagine, even if you had just tomorrow’s newspaper what type of riches you could create from sports betting to stock picks.  I often joke with my clients, that if I had a time machine, I would be hand down the best investor of all time. 

It’s fun to fantasize about it, to joke about it, to laugh about it, and then… back to reality.  We don’t have a time machine and our results won’t always be the best – that is our reality.  And benchmarks can be distracting, whether we are talking soft drinks or stocks.  What you need to decide is what is important to you – your financial plan, your goals, your objectives, etc. – and you need to keep your eyes on the prize.   

So, that’s my ask of you, my word of encouragement, to make sure you are measuring your outcomes with the right benchmarks – the type of metrics that keep you on track rather than lead you off track.    

The Bahnsen Group is registered with HighTower Securities, LLC, member FINRA and SIPC, and with HighTower Advisors, LLC, a registered investment advisor with the SEC. Securities are offered through HighTower Securities, LLC; advisory services are offered through HighTower Advisors, LLC.

This is not an offer to buy or sell securities. No investment process is free of risk, and there is no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is not indicative of current or future performance and is not a guarantee. The investment opportunities referenced herein may not be suitable for all investors.

All data and information reference herein are from sources believed to be reliable. Any opinions, news, research, analyses, prices, or other information contained in this research is provided as general market commentary, it does not constitute investment advice. The team and HighTower shall not in any way be liable for claims, and make no expressed or implied representations or warranties as to the accuracy or completeness of the data and other information, or for statements or errors contained in or omissions from the obtained data and information referenced herein. The data and information are provided as of the date referenced. Such data and information are subject to change without notice.

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This document was created for informational purposes only; the opinions expressed are solely those of the team and do not represent those of HighTower Advisors, LLC, or any of its affiliates.

About the Author

Trevor Cummings

Private Wealth Advisor, Partner

Trevor is a Partner and Director of our Private Wealth Advisor Group.

As the author of TOM [Thoughts On Money], Trevor endeavors to write and speak about financial concepts and principles in a kind of “straight” talk demeanor and posture.

He received his Bachelor’s degree in Organizational Leadership from Biola University and his MBA from California State University, Fullerton.


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