Investors who hear the word “benchmark” often use it interchangeably with the word “index.”

But there are differences between the terms, and Index Industry Association member FTSE Russell aims to clear up misconceptions with its report, “Indices and Benchmarks Made Clear”, authored by David Sol, FTSE Russell Managing Director and Global Head of Policy and Governance. 

While an index is a “calculation that represents a hypothetical portfolio of securities designed to represent an asset class, market or market segment” a benchmark is a “category of index that’s used for reference purposes” such as measuring portfolio performance and evaluating risk in a strategy. 

The distinction is important, especially as the use of indices and benchmarks in the professional investment business continues to grow, particularly with the rise of passive investing. 

In the report, which is aimed at pension fund trustees, David Sol reviews guidelines for benchmark and index selection. 

Sol writes that every market-leading benchmark should be comprehensive, transparent and objective, regularly rebalanced and maintained, and modular.

When it comes to selecting the right index as an investment vehicle, Sol notes emphasizes that investors cannot directly invet in an index, likening an index to a recipe in a cookbook.

“(The index) sets out the ingredients necessary to make a dish, together with the instructions to combine them” but is “not the dish itself.”  

Sol points out that asset managers and banks use indices to create a variety of investment products including ETFs, mutual funds, swaps, separately management accounts, and other products.