How do you know if your mutual fund scheme has performed well?  Some investors use personal perceptions when evaluating their scheme’s performance e.g. 15%+ returns are good for equity funds, less than 10% returns are poor for equity etc. However, such subjectivity can often lead you to incorrect conclusions and harm your financial interests in the long run. In this article, we will discuss about mutual fund benchmarks and how you can use them to evaluate performance of mutual fund.

Why do we need benchmarks?

Your equity scheme gave 15% return in the last one year. Is this performance good or bad? Like performance measurement in other walks of life e.g. education, career etc, investment (especially market linked investments) performance should be evaluated on relative basis. If the market gave 25% return in the last one year and your scheme gave 15% return, then performance of mutual fund scheme you have invested in cannot be good. If your scheme gave -5% returns in the last one year, is it bad performance? If the market fell 20% and your scheme gave -5% returns, then it is excellent performance. The fund performance should always be evaluated against the mutual fund benchmark.

What is a market benchmark?

A benchmark is an index against which a mutual fund’s performance is measured. Examples of market benchmarks are Nifty 50 TRI, Nifty 100 TRI, Nifty Large and Midcap 250 TRI, Nifty Midcap 150 TRI etc. SEBI requires all mutual fund schemes to mention their respective market benchmark indexes in their Scheme Information Documents (SIDs). All schemes, equity, hybrid, debt, solution oriented, fund of funds etc, need to have market benchmark indexes. Fund houses show the performance of all their schemes relative to the market benchmark indexes in their monthly fund factsheets. This helps you do mutual fund performance comparison.

What are the characteristics of benchmark index?

• The purpose of a benchmark is to reflect the performance of an asset class or sub-category
• A benchmark index needs to have clearly defined rules (including weighting methods), which are generally acceptable by all
• A benchmark should be accurate and reliable
• Benchmark values should be available on daily basis to enable comparison with mutual fund scheme performance
• SEBI vide its circular in February 2018 requires all mutual fund schemes to use Total Returns Index (TRI) to evaluate fund performance. TRI includes both price appreciation and income (dividends). To know more about total returns, please refer to chapter 1 of this module. 

How mutual fund schemes choose benchmarks?

A mutual benchmark should accurately represent the weighted average price of the universe of stocks in which a mutual fund scheme intends to primarily invest in. For example, a large cap fund invests primarily in Top 100 companies by market cap. So a large cap fund may choose Nifty 100 TRI or BSE 100 TRI as its benchmark indices.

A large and midcap fund, which invests both in large and midcap stocks, may choose Nifty Large & Midcap 250 TRI as a benchmark index. A midcap fund, which invests primarily in 101^st to 250^th company by market cap, may choose Nifty Midcap 150 TRI as its benchmark index. A multi-cap or flexi-cap fund, which invests across large, mid and small caps, may choose Nifty 500 TRI as its benchmark index. A Nifty index fund may choose Nifty 50 TRI as its mutual fund benchmark index.

These are just some examples. Two schemes within the same fund category may have different benchmark indices depending on their primary investment strategy. For example, one midcap scheme may have Nifty Midcap 100 TRI as its benchmark index, while another may have Nifty Midcap 150 TRI as its benchmark index. You should always compare the performance of mutual fund schemes relative to its benchmark index. As mentioned earlier, all mutual fund schemes mention their benchmark index in their Scheme Information Documents (SIDs). Benchmarks are also mentioned in the monthly fund factsheets. If the fundamental attributes of a scheme changes, then the fund house may also change the benchmark index. You should be aware of these changes, if a scheme you have invested has undergone a change in fundamental attributes.

How to use benchmarks?

• You can compare the performance of mutual fund scheme with the performance of a benchmark over the same time-scales. However, you should not only compare short term relative performance in evaluating fund performance. You should always evaluate a scheme based on its long term relative performance versus the benchmark.
• You can compare two schemes with the same benchmark in the same category, by seeing each of them performed versus the benchmark. If scheme A outperformed the benchmark by 3%, while scheme B outperformed by only 1%, then scheme A is clearly the better performer.