Importance Of Benchmark In Mutual Funds

The standard against which the performance of an MF scheme is measured is known as a benchmark. In India, the declaration of a benchmark index is compulsory, according to the regulatory guidelines implemented by the SEBI or Securities and Exchange Board of India.

The benchmark is constituted by an unmanaged group of securities. These become a benchmark for a stock or MF scheme. Here, the performance of the stock or the MF scheme is measured against the benchmark. For instance, broad market indices like National Stock Exchange (NSE) Nifty and Bombay Stock Exchange (BSE) Sensex are benchmarks that invest in large-company stocks. CNX Smallcap, S&P BSE 200, and CNX Midcap are some other examples of benchmarks. 

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Why should you care about benchmarks?

Benchmarks can be a handy tool while comparing MF schemes as the benchmark returns mutual funds are indicative of how much your fund has earned in comparison to how much it should have. Typically, your MF scheme’s target should be the benchmark’s return. If your MF scheme beats the benchmark, it is considered to have done well.

You can gauge the performance of your scheme by reviewing whether your funds have beat the benchmark. If the returns exceed the benchmarked values, then your scheme has outperformed. And if the benchmark collates higher returns than your MF scheme, your funds have underperformed.

The fund house determines your MF scheme’s benchmark index. So, if a fund is underperforming against its benchmark, investors should reconsider investing in it.

The MF schemes are directly affected by the peaks and slumps of the market. For instance, if diversified equity mutual fund schemes are benchmarked to Sensex, then the returns will be measured against Sensex's performance. Here, when the market is bullish and the money movement of Sensex is positive, then an adeptly managed fund should collect market-beating returns.

Furthermore, before investing, it’s prudent to review the mutual fund’s performance in comparison to its benchmark over the longer term. That’s because short term returns can be highly volatile; hence, comparing short-term performance can give false hope.

Fund houses generally choose benchmark indices depending on various factors such as market capitalization, sectoral or thematic strategies of the investment, etc. Typically, large-cap funds are more suited to beginner investors and investors with a relatively lower risk appetite. On the other hand, small and mid-cap funds are better suited to sophisticated investors and investors with a higher risk appetite.

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Over to you

The different types of benchmarking indices available for the MF schemes provide you with a clear-cut perspective about the fund’s performance and portfolio. This way, you are more informed to make an investment decision depending on your return expectations.

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