About Mutual Fund Benchmarks
Going by its literal definition with respect to financial investments, a benchmark is a standard against which you can measure the performance of a mutual fund, security or an investment manager. In the context of mutual funds per se, it’s a point of reference that tells you about a mutual fund’s performance as against the market and its peers. SEBI (Securities and Exchange Board of India) has made it mandatory for all mutual fund houses to declare their respective benchmark indices.
Hence, all mutual fund schemes, whether equity or debt funds, select and declare their own benchmarks. For instance, Nifty and BSE Sensex are the most commonly used benchmarks for large cap equity mutual funds in India. Some of the other regularly used benchmarks for equity funds are Nifty 500, Nifty Next 50, Nifty 100 etc.
For instance, if a particular mutual fund benchmarks against Nifty 500, it reflects on the capabilities of its fund management team. . Comparing a portfolio's returns to a benchmark is also a way to measure a portfolio manager's skill. The selection of a particular benchmark by a mutual fund also in a subtle manner indicates the kind of stock holdings, the risks involved and its portfolio strategy.
In creation of a well-diversified mutual funds portfolio
In continuous fund evaluation
- Whenever you go about creating a well-diversified mutual funds portfolio, one of the main fund selection drivers used is the diversification across different market capitalizations. Looking at the benchmark indices of different mutual funds can help you in selecting the right mutual funds having ample exposure to a specific market.
- For instance, if you wish to invest into theme-based funds that invest primarily into pure small cap, pure mid cap or pure large cap equities, you may go with funds that benchmark against S&P BSE SmallCap Select Index, S&P BSE MidCap Select Index and Nifty/Sensex respectively. On the other hand, if you are more inclined towards border funds that follow a mix market cap or multi-cap strategy, you’d be better served by investing into mutual funds that benchmark against S&P BSE 500 or Nifty 500.
- When you’re engaged in constant fund evaluation for gauging the performance of your investments, benchmarks can help you ascertain the actual performance of your mutual fund investments.
- Even if a fund beats its benchmark consistently, it is still advisable to observe and analyze the margin of outperformance. However, one must also note that if an actively managed fund continues to deliver returns in-line with the benchmark, it may be considered as underperformance. However, there is also the potential possibility of a fund under-performing, below the benchmark as well. Hence, the benchmarking should be used as a tool to decide and reconsider one’s investments from time to time.
- Although benchmarks serve as good means for studying the performance of different mutual funds, you shouldn’t go by them alone and focus on the funds’ factsheets as well.