So you need a reference value – a benchmark – that allows you to evaluate the success of your investment. For investment fund managers – and their customers – this is a (stock market) index which reflects the universe of stocks in which the fund invests.
For a fund investing in German stocks, for example, this will be the DAX index calculated continuously by the Frankfurt Stock Exchange. “The DAX” is calculated based on the share prices of the 30 largest and most actively traded German companies. If stock prices rise, the index goes up, and vice versa. The DAX is considered an indicator for the overall development of the German stock market.
But beware: If the DAX rises by 1%, this does not mean that the share prices of all 30 companies it contains also rise by 1%, far from it. Some stock prices increase more than others, others increase less, still others even fall.
What does this mean for our investment fund which invests in German equities?
Well, if the DAX has risen by 10% during a given period, while the value of our investment fund increased by only 4% during the same period, this means that the fund manager did not benefit from the generally good performance of the German stock market and that he did not make a good choice when selecting the stocks in which he invested the money the investors entrusted to the fund.
However, if the value of our fund increased by 13% over the same period for example, this shows that the fund manager had a fine flair to identify those securities that have increased more than the average.