In what situation can broad market indices become inappropriate benchmarks?

Broad market indices serve as benchmarks to evaluate the performance of investment portfolios, but their appropriateness can diminish under specific circumstances. When a manager's style deviates significantly from the overall market, these indices may not accurately reflect the risk and return characteristics of the portfolio being assessed. For example, if a fund manager employs a focused investment strategy targeting growth stocks, using a broad market index that includes a diverse mix of value stocks, bonds, and cash equivalents might not adequately represent the manager's investment style or performance. Consequently, the index would fail to provide a relevant standard for comparison, making it challenging to evaluate the manager's effectiveness meaningfully.

By contrast, scenarios like high management fees or low market volatility do not inherently affect the benchmark’s relevance; they relate more to costs or market conditions rather than the alignment of the portfolio's investment strategy with the benchmark. Similarly, if a fund targets a single asset class, while it might seem misaligned, broad indices could still be utilized if they include that asset class, thus maintaining their relevance. Hence, a significant deviation in a manager's style is the key factor that can render broad market indices inappropriate as benchmarks.