Beyond returns: How benchmarking helps investors pick winning mutual funds

WHAT IS A BENCHMARK IN MUTUAL FUNDS?

A benchmark is a standard against which a mutual fund scheme’s performance is measured. Market regulator Sebi requires every mutual fund scheme to declare a benchmark index, regardless of its category. The benchmark acts as a yardstick that helps investors judge how well a mutual fund has performed. It helps investors see whether a fund has done better or worse than the market

WHAT ARE SOME POPULAR BENCHMARKS USED BY MUTUAL FUNDS?
Most large-cap equity funds use the Nifty 50 TRI or Sensex as their benchmark. Other commonly used equity benchmarks include the Nifty Midcap 150 TRI, Nifty Smallcap 250 TRI and Nifty 500 TRI. In debt funds, liquid funds are often benchmarked against the CRISIL Liquid Debt Index, while gilt funds may use the CRISIL Dynamic Gilt Index.

WHY IS A BENCHMARK IMPORTANT FOR FUND MANAGERS AND INVESTORS?

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A benchmark acts as a reference point for both fund managers and investors. For fund managers, it provides a target against which they can measure the performance of their investment decisions. For investors, it helps them assess whether a fund is doing better or worse than the market or the segment it invests in. Without a benchmark, it is difficult to judge how well a fund has performed.

WHY IS BENCHMARKING OF RETURNS CRITICAL FOR INVESTORS?
Returns should never be viewed in isolation. A mutual fund is considered to have outperformed only if it delivers higher returns over its benchmark over a given period. For example, if a scheme generates a return of 16% after expenses while its benchmark returns 12%, the fund has outperformed by 4 percentage points.WHAT IS A GOOD LEVEL OF OUTPERFORMANCE OVER THE BENCHMARK?
There is no fixed number. Even a fund that beats its benchmark by 1-2 percentage points a year on a consistent basis can make good money over the long term. More important than one year’s outperformance is consistency. Investors should look for funds that have outperformed their benchmark across market cycles and over longer periods such as five and ten years.

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