What is a Mutual
Fund Benchmark?
Back in the days,
if you recall going home to break your exam results to your parents, it wasn’t
an easy thing to do. After scoring 60% in one of the papers which was rather
tough, you come up with a range of explanations making your parents understand
how difficult the paper was. You then go on to claim that most of your
classmates scored lower marks or that the class topper scored 68% which wasn’t
too far from your own score. But, after giving all the valid reasons to
convince them that the paper was a tough nut to crack, you are however
reprimanded for not performing well. Surely, you would be disappointed that
they are not trying to reason with you as to how tough the paper was.
Now take for
instance a mutual fund’s performance for the past one year period. It came down
7.5% during that period. In this case would it be right to say that the fund
performed badly? It would be fair to compare the fund’s performance to a
standard as you compared your performance to that of your classmates. A
standard is thus the fund’s benchmark that helps to facilitate the
understanding of any performance.
What is a Benchmark?
It is but a common thing that an investor would notice in his/her inbox on a regular basis, the various marketing communication emails and mutual fund advertisements declared by fund houses that particular funds have earned XX% returns and that if invested in such funds, investors would earn such returns. It is important to understand the significance of using a benchmark for the purpose of effective comparison which sadly many investors fail to understand. Since 2012, for the sake of standardization, SEBI (Securities and Exchange Board of India) has made it mandatory for fund houses to declare a similar return in INR and by way of CAGR in addition to the scheme benchmark performance.
It is but a common thing that an investor would notice in his/her inbox on a regular basis, the various marketing communication emails and mutual fund advertisements declared by fund houses that particular funds have earned XX% returns and that if invested in such funds, investors would earn such returns. It is important to understand the significance of using a benchmark for the purpose of effective comparison which sadly many investors fail to understand. Since 2012, for the sake of standardization, SEBI (Securities and Exchange Board of India) has made it mandatory for fund houses to declare a similar return in INR and by way of CAGR in addition to the scheme benchmark performance.
A scheme's
benchmark is an index that is decided by its fund house to serve as a standard
for the scheme's returns. The BSE Sensex and Nifty are the most generally used
benchmarks in India for mutual fund investments. Other benchmarks are Nifty
500, Nifty 100, CNX Midcap, CNX Smallcap, S&P BSE 200 etc. Investors are
given an opportunity to compare the performance of their investments with that
of the broader market. Take for instance you are investing in a diversified
equity fund that is benchmarked against the BSE Sensex. Its returns are thus
compared with that of BSE Sensex. Hence a large-cap fund’s performance needs to
be compared against a large-cap benchmark and vice-versa. Once you know the
performance, you can decide whether to enter or exit a mutual fund.
Mutual Fund Performance with respect to the
Benchmark
This is always the case that a mutual fund gets hit with force whenever the market scales new heights or comes crashing down. Let’s take for instance a diversified equity fund - Fund A is benchmarked against the Sensex. Its returns are hence compared with that of the Sensex. Now suppose the fund achieved 40% returns though the Sensex earned 50% returns, it would mean that Fund A underperformed its benchmark. While on the other hand, if the fund achieved 50% returns and the Sensex generated only 30%, it would mean that Fund A outperformed its benchmark. There are some situations where a fund generates similar returns as that of its benchmark. Such cases are said to be considered as fund underperformances as the main intent of actively managed equity mutual fund investing is to perform better than the benchmark.
This is always the case that a mutual fund gets hit with force whenever the market scales new heights or comes crashing down. Let’s take for instance a diversified equity fund - Fund A is benchmarked against the Sensex. Its returns are hence compared with that of the Sensex. Now suppose the fund achieved 40% returns though the Sensex earned 50% returns, it would mean that Fund A underperformed its benchmark. While on the other hand, if the fund achieved 50% returns and the Sensex generated only 30%, it would mean that Fund A outperformed its benchmark. There are some situations where a fund generates similar returns as that of its benchmark. Such cases are said to be considered as fund underperformances as the main intent of actively managed equity mutual fund investing is to perform better than the benchmark.
Outperformed or Underperformed
|
Mutual
Fund Performance with respect to the Benchmark
|
|
|
If returns are greater than its benchmark returns
|
Fund has outperformed
|
|
If returns are lesser than its benchmark returns
|
Fund has underperformed
|
A benchmark is an
important tool that helps to measure a fund’s performance. To avoid any
misunderstandings, an appropriate benchmark needs to be selected. Keep in mind
that a benchmark performance is not the only criterion to select a mutual fund
to invest in. Therefore, consult your financial advisor, understand your own
risk appetite and assess your needs before taking any investment decisions.
No comments:
Post a Comment