What is a Mutual Fund Benchmark?

Back in the days, if you recall going home to break your exam results to your parents, it wasn’t an easy thing to do. After scoring 60% in one of the papers which was rather tough, you come up with a range of explanations making your parents understand how difficult the paper was. You then go on to claim that most of your classmates scored lower marks or that the class topper scored 68% which wasn’t too far from your own score. But, after giving all the valid reasons to convince them that the paper was a tough nut to crack, you are however reprimanded for not performing well. Surely, you would be disappointed that they are not trying to reason with you as to how tough the paper was.

Now take for instance a mutual fund’s performance for the past one-year period. It came down 7.5% during that period. In this case would it be right to say that the fund performed badly? It would be fair to compare the fund’s performance to a standard as you compared your performance to that of your classmates. A standard is thus the fund’s benchmark that helps to facilitate the understanding of any performance.

What is a Benchmark? It is but a common thing that an investor would notice in his/her inbox on a regular basis, the various marketing communication emails and mutual fund advertisements declared by fund houses that particular funds have earned XX% returns and that if invested in such funds, investors would earn such returns. It is important to understand the significance of using a benchmark for the purpose of effective comparison which sadly many investors fail to understand. Since 2012, for the sake of standardization, SEBI (Securities and Exchange Board of India) has made it mandatory for fund houses to declare a similar return in INR and by way of CAGR in addition to the scheme benchmark performance.

A scheme’s benchmark is an index that is decided by its fund house to serve as a standard for the scheme’s returns. The BSE Sensex and Nifty are the most generally used benchmarks in India for mutual fund investments. Other benchmarks are Nifty 500, Nifty 100, CNX Midcap, CNX Smallcap, S&P BSE 200 etc. Investors are given an opportunity to compare the performance of their investments with that of the broader market. Take for instance you are investing in a diversified equity fund that is benchmarked against the BSE Sensex. Its returns are thus compared with that of BSE Sensex. Hence a large-cap fund’s performance needs to be compared against a large-cap benchmark and vice-versa. Once you know the performance, you can decide whether to enter or exit a mutual fund.

Mutual Fund Performance with respect to the Benchmark This is always the case that a mutual fund gets hit with force whenever the market scales new heights or comes crashing down. Let’s take for instance a diversified equity fund – Fund A is benchmarked against the Sensex. Its returns are hence compared with that of the Sensex. Now suppose the fund achieved 40% returns though the Sensex earned 50% returns, it would mean that Fund A underperformed its benchmark. While on the other hand, if the fund achieved 50% returns and the Sensex generated only 30%, it would mean that Fund A outperformed its benchmark. There are some situations where a fund generates similar returns as that of its benchmark. Such cases are said to be considered as fund underperformances as the main intent of actively managed equity mutual fund investing is to perform better than the benchmark.

Outperformed or Underperformed

Mutual Fund Performance with respect to the Benchmark

If returns are greater than its benchmark returns Fund has outperformed

If returns are lesser than its benchmark returns Fund has underperformed

A benchmark is an important tool that helps to measure a fund’s performance. To avoid any misunderstandings, an appropriate benchmark needs to be selected. Keep in mind that a benchmark performance is not the only criterion to select a mutual fund to invest in. Therefore, consult your financial advisor, understand your own risk appetite and assess your needs before taking any investment decisions.