Use Benchmark index as mutual fund’s performance barometer

 

   The Securities and Exchange Board of India [SEBI] has made it mandatory for mutual funds to declare a benchmark. A mutual fund's benchmark is usually an index that is chosen by a fund house to serve as a standard for its returns. For example, the Sensex and Nifty in India are the most widely followed benchmarks for funds that invest in large-company stocks.

WHY BENCHMARK    

To put it very simply, a benchmark gives a layman an opportunity to compare the performance of his investments with that of the broader market. At the same time, a fund house can also set target returns and strive to perform better than the benchmark index.

WHAT IS BENCHMARKING    

When the market rises or falls, the fund will be impacted. However, the degree of impact varies from fund to fund. Let's consider a diversified equity fund that has benchmarked itself against the Sensex. In the simplest case, if the fund does better than Sensex, it has outperformed the benchmark and vice-versa.

   However, if the markets are doing extremely well and the Sensex keeps moving upwards consistently, then anything less than the Sensex returns from the fund, though good, would actually be an underperformance.

   Lastly, if the Sensex drops over a period of time and during that time the fund's NAV drops by less, in percentage terms, then the fund it is said to have outperformed the benchmark.

MEASURING PERFORMANCE    

Beta compares the volatility in the NAV of a fund to that of its benchmark. A fund with a beta of more than 1 is considered to be more volatile than the benchmark and vice-versa. In the median case, a beta of 1 implies that the volatility of a fund is totally in sync with that of the benchmark.

 

   So, for instance, a fund with a beta of 1.10 can be expected to fluctuate 10 per cent more than the benchmark when the market is up and if the market heads lower, the fund should fall by 10 per cent more. If the fund has a beta of 1, it can be expected to fluctuate in just the same magnitude as its benchmark.

 

TO CONCLUDE    

 

Comparing the performance of a fund to that of its benchmark gives an investor deeper insights into the situation. A fund manager can claim to have 'outperformed' the market, even if unitholders lose money by saying his scheme's net asset value has fallen less than the benchmark. Similarly, he can be tagged an underperformer, even after delivering good returns, if benchmark indices have performed better.

 

SUMMING UP

 

• A benchmark enables comparison of the performance of a fund with that of the broader market.
• In the simplest case, if the fund does better than Sensex, it has outperformed the benchmark and vice-versa.
• Beta is a statistic which compares the volatility in the NAV of a fund to that of its benchmark.