When is the benchmark portfolio used in optimal allocation?

The benchmark portfolio is utilized in optimal allocation specifically when the optimum allocations to managers do not sum to one. This situation typically arises in investment management when a portfolio manager has various strategies or investment vehicles and determines the optimal allocation percentages for each. In this context, the benchmark serves as a point of reference to evaluate the performance of the selected managers relative to a standard market or sector performance.

When the sum of the allocations assigned to each manager is less than one, it indicates partial investment, which necessitates analyzing whether the remaining capital should be allocated differently or retained as cash. Conversely, if the total exceeds one, it signals an over-commitment of funds, which isn't a rational strategy. Thus, the benchmark portfolio becomes crucial at this juncture for guiding adjustments and ensuring the overall strategy remains aligned with investment goals.

This understanding helps to ensure that each decision made about allocations to different managers is grounded in performance expectations set by the benchmark, facilitating more strategic and effective portfolio management.