Investors often receive mutual fund advertisements and marketing communications claiming that a particular fund has delivered X% return or that investors in a particular scheme have become richer by Rs. Y. While these claims sound good, one must compare the performance of these funds with that of the broader market to understand the significance of such claims. This is where a mutual fund benchmark is highly useful.

What is a Benchmark?

A benchmark, as the name suggests, is a point of reference that tells you how a mutual fund has performed vis-a-vis its peers and the market. In the year 2012, SEBI made it mandatory for fund houses to declare a benchmark index. This benchmark is independent and is based on the objectives of your fund.

In India, the BSE Sensex and the Nifty are the most widely followed benchmarks for large-cap funds. Other benchmarks are CNX Midcap, CNX Smallcap, CNX IT, CNX 500, BSE 200, BSE 100, etc. Hence, if you invest in a diversified equity fund that is benchmarked against the BSE Sensex, its return is compared with that of BSE Sensex.

Understanding Performance w.r.t the Benchmark

If your fund delivers higher returns than the benchmark, it is said to have outperformed and vice versa. On the other hand, if the benchmark index falls over a period of time and during the same time, your fund’s NAV falls lesser (in percentage terms), your fund can still be said to have outperformed the benchmark.

One must note that if an actively managed fund delivers returns in-line with the benchmark, it should be considered as underperformance. This is because a professional fund manager has charged you a fee and only delivered returns equal to an index fund (a passively managed scheme that does not engage a fund manager).

Hence,

Fund Performance greater than Benchmark is Outperformance

Fund Performance less than Benchmark is Underperformance

Fund Performance equals to Benchmark is Underperformance

Measuring Performance

Ascertaining whether a fund has outperformed is an important criterion while selecting a mutual fund. You can determine this looking over your fund’s historical returns.

The performance of your fund vis-a-vis its benchmark is measured by a unit termed Beta. It is the measure of the volatility of your fund compared to its benchmark. If the beta of your fund is 1.10, you can expect 10% higher returns than the benchmark in an upward market, and 10% lower returns than the benchmark in a downward market. A beta of 1 implies that your fund will fluctuate in sync with its benchmark.

Importance of Long-Term Performance

When comparing a scheme with its benchmark, ensure that you consider the performance of the fund over 1 year, 3 year, 5 year and even 10 year returns (if the data is available). A funds ability to consistently outperform its benchmark is a highly desirable trait.

However, the benchmark performance is not the only yardstick for finalizing a fund to invest in. Note that past performance does not guarantee future returns. Hence, it is imperative to consult your financial provider and evaluate your risk appetite before making an investment.

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