For example, if you have an actively-managed stock portfolio, it is useful to compare its performance to a simple passive index portfolio. The difference between the performance of your portfolio and a passive index may reflect the value added by active management. If, for example, your portfolio earned 16 per cent while a suitable or appropriate benchmark earned 13 per cent, then you would surmise that your active selection added three per cent in value. In order to benchmark your portfolio properly you need to use an appropriate index. An index is simply a proxy for some underlying basket of securities.
Some indexes are unrepresentative of a recognizable sector.
The problem with most pure indexes is that they are unmanaged. They do not contain management, administration, transaction costs and other expenses associated with actually maintaining the underlying basket. An index should be representative of a particular market segment. A sector index such as an oil and gas may be representative of oil and gas investments, although clearly not so for the broad market. On the other hand, if the benchmark is very broad it has the merit of being representative, but it may not be investable.