What is Benchmark in Mutual funds?
Introduction
Whenever you invest in mutual funds, you should have come across the term ‘benchmark’. But you might not have known what does an ‘mutual fund benchmark’ mean and how does it impact your invested amount. In this article, let us understand the concept of benchmark in mutual funds in detail.
What is a benchmark?
A benchmark is defined as a standard against which the performance of a mutual fund scheme is measured. Benchmark provides an indicative value of the returns that one’s investment should have earned. This can be compared against how much the investment has originally earned. In 2012, SEBI made it mandatory that the fund houses should declare a benchmark index for every scheme. Preferably, the mutual fund’s target should be to match or exceed its benchmark returns.
Mutual fund houses generally determine the Benchmark for a particular investment. Such Benchmark is considered as the base standard of that mutual fund scheme.
The below table depicts the details of mutual fund schemes with their benchmark:
| Scheme Name | Benchmark |
|---|---|
| Mirae Asset Large Cap Fund | NIFTY 100 Total Return Index |
| Axis Bluechip Fund | NIFTY 50 Total Return Index |
| Canara Robeco Bluechip Equity Fund | S&P BSE 100 Total Return Index |
| SBI Bluechip Fund | S&P BSE 100 Total Return Index |
| Tata Large Cap Fund | S&P BSE Sensex Total Return Index |
What Is Benchmark In Mutual Funds?
People who invest in mutual funds, depend on the fund manager to confide their money to them. In mutual funds, benchmarks help the investors to know and understand how effectively their funds are being managed over time. If a particular mutual fund scheme gives more returns as compared to benchmark index, it is considered that the scheme is performing better.
According to the financial experts, if the performance of a mutual fund scheme is equal or less than that of the benchmark index, then the fund manager is under achieving. The fund manager should be more vigorous and should have aimed to perform much better than the benchmark index.
However, if the returns are as similar as the benchmark index, then there is a possibility that the investor might have invested in the index while redeeming the fees that are being given to the fund manager. If the fund manager is regular with the paybacks and performing better compared to the benchmark over a while, the demand for that fund increases
Importance of Benchmark in mutual funds
To understand the importance of Benchmark in mutual funds, we need to compare funds’ performance to benchmark.
• The return which you get from Benchmark will give you a quality standard with which you can do the comparison. It helps you to understand what the fund has earned and what it should have earned.
• Benchmark provides an opportunity for the investors to make a comparison of their investment with the broader market. Normally, the fund house set a goal to do better than the benchmark index.
A selected fund that has the same stock might over-perform a given benchmark. These variances are known as Volatility. To understand this better, investor can only see the Standard deviation on the performance of the fund to get an idea.
How does Benchmark work in Mutual Funds?
According to some financial experts, investors should be concerned about absolute return. Absolute returns are the amount that one’s investment has acquired. The return which you get from the equity market is most of the time volatile, sometimes you get high returns and sometimes you get an exceptionally low return. What matters is if your payback can beat the market on regular intervals, so it should give a boost in your confidence that you can meet your investment objectives.
It is important to remember few points here:
• The understanding of Long-term investment changes from one investor to the other. Some investors’ investment horizon could be 3 years while others’ horizon could be 10 years. Based on the time of investment, fund category needs to be selected and then based on that category one should select the fund. The benchmark will change based on which category of fund is selected.
• Be practical in terms of expectation, you cannot assume the fund manager to beat the stock market every month. The fund manager has a goal to beat the benchmark over a reasonable period of time.
• Your invested fund may not have the broader market index as benchmark so if say Nifty goes up you don’t expect your investment to go up because you could have invested in the small cap category and the benchmark for that fund is not Nifty index.
• Examine the portfolio of your mutual fund carefully to make sure that the benchmark is appropriate for the fund from the information document and factsheet.
What are the ratios used by Fund houses for benchmarking index?
Fund houses also use ratios to evaluate the performance of mutual funds. These ratios are mainly based on some type of benchmarking index depending on the type of the scheme – Large, Mid or Small cap fund.
Alpha: In this form of investment, the portfolio is not churned regularly. This method is passive in nature and the investors are aware of the investment mandate because it is based on the predefined guidelines.
Beta: Beta defines the risk associated with a particular mutual fund scheme depending on its benchmark index. If the beta is less than 1, then the scheme is less risky compared to its benchmark index and vice-versa.
R-squared: R-squared measures the performance of a mutual fund scheme affected by its benchmark. It has percentage from 0 to 100 where 0 represents the lowest correlation and 100 being the exact.
Conclusion
It is very necessary to examine and understand benchmarking of mutual funds, especially those who are doing investment in mutual funds for the first time. If the funds you have invested are outperforming their market benchmarks on a consistent basis despite volatile market conditions, chances of your fulfilling your investment goals are high.
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