Concept of Benchmark
While reading a mutual fund offer document, you will often come across the word – Benchmark. So let’s understand what it is? And why is it useful for you?
What is a Benchmark?
To put it simply, a benchmark is a standard against which the performance of a mutual fund is measured. It reflects how a particular mutual fund scheme has performed vis-à-vis a well-established index such as BSE Sensex or NSE Nifty over a particular period of time. The target of every mutual fund scheme is to at least match the performance of the benchmark or over perform it.
SEBI has mandated all mutual funds to quote the benchmark index in the offer document. Some of the most commonly mentioned benchmarks for equity funds in India are the BSE Sensex, NSE Nifty, CNX Midcap, CNX Smallcap, S&P BSE 200, etc.
Let us understand this through an example.
SBI Bluechip Fund is one of the top-performing open-ended bluechip mutual funds of India. Its benchmark index is S&P BSE 100 Index, as indicated in figure 1 attached below. This means that one can compare the fund’s performance with the S&P BSE 100 index to measure the performance of the fund.
The fund management team chooses the benchmark for a mutual fund taking into account a variety of factors such as market focussed on, sectoral and thematic strategies and others. Thus, a large-cap fund will choose a large-cap index such as BSE Sensex as its benchmark while an IT focussed fund will choose an IT-related index such as S&P BSE IT as its benchmark index.
Why is the Benchmark Important?
One may wonder about the need to have a benchmark. Why can’t we measure a fund’s performance from its absolute returns or CAGR alone?
Having a benchmark helps investors compare a fund’s returns and understand whether the fund has over-performed in a given period of time, or under-performed or remained at par.
Let us take our earlier example of the SBI Bluechip Fund and understand how has it performed vis-à-vis its benchmark index:
Data were taken on 30.09.2021
As you can see, the fund has more or less given similar returns compared to its benchmark index. This is a sign of a well-managed fund and reflects the able decision making of the fund management team.
Comparing a fund to its benchmark is a great tool to use while realigning your portfolio and understanding whether you should remain invested in a fund or exit. However, please keep in mind that one should stay invested for at least a year in a fund before evaluating its performance to its benchmark. Moreover, unless there is a significant difference between the returns of the benchmark and the mutual fund, deciding to exit may not be a good idea.