Sector vs Factor-based Benchmark Selection

Same, same, but different?

September 2022. Reading Time: 10 Minutes. Author: Nicolas Rabener.


  • Manager-selected benchmarks are suboptimal as they are not free of conflict of interests
  • Investors can use sectors to identify more appropriate benchmarks
  • However, this ignores factors, which are better at explaining investment returns


In our last research article (read Mirror, Mirror on the Wall, which is the fairest Benchmark of them All?) we highlighted that investors can use factor exposure analysis to identify and select the most appropriate benchmark for a mutual fund, or even a portfolio with diverse assets.

Investors generally rely on the choice of benchmark provided by the asset manager, but these are not necessarily the most suitable as fund managers want to portray their performance in the most favorable way, i.e. there is a conflict of interests. The mantra should be “trust, but verify”.

However, instead of using factors, investors could also use sectors for creating a systematic benchmark selection process, which may seem to be more intuitive, especially when evaluating sector-focused funds.

In this research article, we will contrast sector with factor-based benchmark selection.


As in the previous analysis, we use the ARKK Innovation ETF (ARKK) as a case study. The ETF’s primary benchmark is the S&P 500 as per the asset manager’s factsheet. ARKK’s portfolio is highly concentrated and holds mainly growth stocks like Tesla, while the S&P 500 represents a diversified portfolio across all sectors, i.e. is unlikely the optimal benchmark.

Given this, we include the S&P 500 Growth index when conducting a simple breakdown by sector analysis. We observe there was some overlap in sectors between ARKK and the two indices, but in some cases, the ETF’s exposure was closer to the S&P 500 Growth than that of the broader S&P 500 index, eg utilities, industrials, or consumer staples.