Measuring What Matters: Beyond Benchmarks & Relative Returns

This article is part of an educational series designed to help investors understand how we approach portfolio construction at Lulworth Investment Partners and the principles that guide the way we build and manage portfolios. It is intended for general information only and should not be viewed as investment advice or a recommendation to buy or sell any asset. Anyone considering an investment should reflect on their own objectives, financial position and tolerance for risk, and seek regulated financial advice if needed.

At Lulworth, our objective is straightforward: to grow our clients’ capital in real terms across a range of market conditions, while managing the risk of permanent capital loss.

In doing so, we assess our performance against inflation, or inflation plus an additional growth target, over a timeframe that reflects each client’s goals and circumstances. In our view, this provides a clearer and more meaningful measure of success than simply comparing returns to a market benchmark.

Much of the investment industry continues to focus heavily on relative returns, measuring performance against indices or peer groups. While these comparisons can provide useful context, they often answer a different question: how has a portfolio performed relative to others, rather than whether it has achieved its intended purpose?

What is a benchmark and what does it tell you?

A benchmark is a reference point used to assess investment performance.

This may be a market index, such as the FTSE 100 or MSCI World Index, a peer group of similar strategies, or a composite benchmark that reflects a mix of assets such as equities and bonds.

These comparisons can be useful. They help investors understand how a portfolio has behaved relative to wider markets or comparable managers.

However, benchmarks measure performance in relative terms. They show how a portfolio has performed compared to something else, but not whether it has delivered the outcome the client actually needs.

For most investors, the purpose of a portfolio is not to track or outperform an index. It is to support specific long-term objectives, whether that means preserving purchasing power, funding future spending, generating long-term growth or maintaining financial security across generations.

That distinction matters. A benchmark may help describe performance, but it does not define success. The exception, of course, is when a portfolio is designed to provide specific asset class, geographic or thematic exposure, in which case, measuring performance relative to a passive index makes complete sense. However, for most individuals, families and charities, this is not likely to be the purpose of their portfolio.

You can’t eat relative returns

The central limitation of benchmark-focused investing is that outperformance does not necessarily translate into a better client outcome.

A portfolio can outperform its benchmark while still delivering disappointing absolute returns. For example, if markets fall sharply, a portfolio that declines by less than its benchmark may be considered successful in relative terms, even though the client has still experienced a material loss of capital.

The issue becomes even more significant when inflation is taken into account. A portfolio may produce positive returns and outperform its benchmark, yet still fail to preserve purchasing power. In real terms, the client may be worse off despite apparently “good” performance relative to the benchmark.

This highlights the gap between how performance is often reported and how investors actually experience it. Relative returns measure success against the market. Most clients, however, are concerned with whether their wealth is maintaining and growing its real value (ahead of inflation) over time.

In our view, this is the more relevant measure.

How benchmarks can shape portfolios

Benchmarks influence more than performance reporting. They also affect how portfolios are constructed.

When managers are assessed relative to a benchmark, there is often pressure to remain close to it. This is commonly described in terms of tracking error, which measures how far a portfolio deviates from its benchmark. In practice, limiting this deviation can become a significant consideration.

The result is that many portfolios end up looking broadly similar, often centred around conventional allocations to equities and bonds that closely resemble the benchmark itself. While this may reduce the risk of short-term underperformance relative to peers, it can also reduce differentiation and constrain diversification.

If portfolios are exposed to similar underlying risks, they are likely to behave similarly when market conditions change. This can create periods in which losses are experienced across a broad range of supposedly diversified strategies.

Benchmark-driven frameworks can also encourage a shorter-term mindset. Frequent quarterly comparisons may incentivise tactical decision-making and reduce patience, even though most investors are investing over many years or decades.

At Lulworth, we take a different approach. Our portfolios are not constructed with reference to a specific benchmark. Instead, we seek to draw on multiple distinct sources of return, with the aim of building portfolios that are more resilient across different market environments.

This gives us greater flexibility in how capital is allocated and reduces reliance on any single asset class, investment style or market outcome. It also allows us to focus on long-term compounding rather than short-term benchmark comparisons.

Why we focus on real returns over time

We believe performance should be judged according to whether a portfolio achieves its intended purpose. In practice, that means focusing on real returns ahead of inflation, over a timeframe that reflects the client’s objectives.

There are several reasons why we believe this framework is both practical and effective.

First, time horizons are intuitive. Regardless of their level of investment knowledge, clients naturally think in terms of time. Objectives are usually linked to specific periods, whether that is funding retirement in ten years, preserving family wealth across generations or supporting spending needs over the next five years.

Second, measuring returns in real terms aligns performance directly with those objectives. Rather than focusing on whether a portfolio has outperformed an index, the emphasis is placed on whether capital has grown sufficiently after inflation to support the client’s long-term plans.

Third, this approach helps ensure that portfolios are constructed appropriately for the investment horizon. Longer timeframes generally allow for greater exposure to assets with higher expected returns, accepting short-term volatility in pursuit of long-term growth. Shorter time horizons typically require a stronger emphasis on capital preservation and liquidity.

Finally, assessing performance against a clearly defined real return objective provides a transparent measure of success. Where agreed objectives are not met, we reduce our fees in the following year. We believe this helps align our interests closely with those of our clients.

Conclusion: measuring what matters

Benchmarks can have a useful role. They provide context and can help investors compare performance across markets and managers.

However, they are not a complete measure of success. An excessive focus on relative returns can encourage portfolios that closely follow indices, reduce diversification and shift attention away from the client’s actual objectives.

Ultimately, the most important question is not whether a portfolio has beaten a benchmark. It is whether it has preserved and grown purchasing power over a timeframe that reflects the client’s goals.

In our view, measuring performance in this way leads to a clearer and more meaningful assessment of success, while keeping the focus on what investors are genuinely trying to achieve.