The benchmark problem: how concentrated markets complicate manager selection

Fund selectors and manager selection teams rarely make allocation decisions on performance alone. Performance sits inside a wider due diligence framework used to assess whether a manager is skilled, their performance repeatable, and ultimately if they’re appropriate for a mandate. To make this assessment, the interpretation of performance is key. Relying only on benchmark-relative returns can be misleading when the benchmark itself does not reflect the opportunity set, constraints, or market conditions faced by active managers, particularly in markets as concentrated as today’s.

In this two-part series, we look at two examples that illustrate this. In this first article, the example shows how a single stock’s rise and removal from an index can distort the comparison for months at a time. In our second article, we consider how standing concentration in a handful of mega-cap names creates the same problem without any single triggering event, and how that effect can flip within a year.

Both scenarios could lead to the same question for a selector: did a manager underperform because of the decisions they made, or because the benchmark itself became an unusually difficult, and potentially unrepresentative, comparison point? To make an informed decision on fund allocation, the selector needs to answer that question – and peer analysis benchmarks play an important role.

The reconstitution effect in mid-cap growth

Palantir’s inclusion in the Russell Mid-Cap Growth Index in 2025 illustrates the challenge well. For much of the first half of the year, the stock was an unusually powerful driver of benchmark returns. According to Bloomberg Professional Services, Palantir represented 8.3% of the index at a point when its market capitalization placed it well outside the typical mid-cap range, and the stock contributed nearly 3 percentage points of the index’s total return through April. Bloomberg calculated that removing Palantir’s impact would have increased the proportion of outperforming mid-cap growth managers from 17% to 46%, a significant change to arise from a proportionately minor adjustment. When Palantir was later removed from the index during its annual reconstitution, the benchmark changed again, and the performance hurdle changed with it. [Bloomberg Professional Services, “Is your benchmark broken? The Palantir paradox,” June 2025]

For a selector, this is not simply a market curiosity. It is a due diligence challenge, and one that peer group benchmarks help address. They do not replace qualitative due diligence, holdings analysis, ESG assessment, factor review, or comparison against a standard index. What they do answer is a narrow and important question: did a manager underperform because of the decisions they made, or because the benchmark became an unusually difficult, and potentially unrepresentative, comparison point?

* Data sourced from Style Analytics. A note on data differences will accompany part two of this series

The charts above show this effect inside the US Mid-Cap Growth peer group. The active return comparison in Figure 1 shows the peer group struggling more against the Russell Mid-Cap Growth Index in the first half of the year, exactly when Palantir’s rapid rise created a difficult hurdle for managers that did not hold the stock at index-like levels. Figure 2 helps explain why that struggle ceased midyear: the index’s active weight in Palantir moved from strongly positive to negative in July, reflecting the stock’s removal at reconstitution. After that point, the Russell Mid-Cap Growth Index became a different, and in this case easier, benchmark for active managers to beat.

For a selector reviewing a manager’s first-half numbers against the index in isolation, the natural read might have been that the manager was falling behind a segment of the market it should have captured. The peer benchmark comparison presents different, and more useful, insight.

Style Analytics calculates a peer group average benchmark for each major peer group, built from holdings data rather than returns alone. That means selectors can go beyond whether a fund beat or lagged an index, and examine which stocks, sectors, and positioning decisions drove the difference between the peer group and the benchmark, turning performance measurement into performance explanation.

Traditional market-cap-weighted indices remain the industry standard, and they are not going away. Used alongside them, peer benchmarks give selectors a second, more representative lens on the same numbers.

Keep an eye out for our second post, which considers the impact standing concentration has on the utility of benchmarks for Large Blend and Large Growth – coming in October.