28 Aug 2017 15:15 IST

Why you should track MF schemes’ benchmarks

Benchmarks are usually provided by third-party independent service providers

As a mutual fund investor, your investments need to meet your saving and financial goals and therefore you need to know how to evaluate the performance of the schemes you have invested in.

While there are different ways to measure performance, be it an absolute return goal, volatility of returns or comparison with other similar MF schemes, one of the reliable ways to measure performance is to compare the scheme’s performance with its benchmark.

Simply put, a benchmark is a standard that can be used to judge or measure the performance of a scheme. Benchmarks are usually provided by third-party independent service providers.

In India, there are three key bodies who provide most of the benchmarks used by mutual funds. These are NSE, BSE and CRISIL. Both NSE and BSE construct, maintain and publish various equity indices. CRISIL also independently publishes various indices, including fixed income indices.

For equity oriented schemes, some of the commonly used indices are BSE (Sensitive) Index, CNX Nifty, BSE 100, BSE 200 or CNX 500. For debt, most mutual funds use CRISIL’s fixed income indices like CRISIL Liquid Index or CRISIL Composite Bond Index. For balanced funds, CRISIL Balanced Fund Index is generally used.

For constructing a benchmark, an eligible list of companies, debt instruments, other assets are shortlisted. These are then ranked on various parameters like market capitalisation, liquidity, volume/turnover, etc. Based on a well-researched proprietary methodology, securities are shortlisted and weights decided.

Index values are calculated and then published. Index values are usually available for five to 10 years, or more. Periodically, index constituents, weights and even methodology may be changed depending on market conditions.

Mutual funds publish the performance of their scheme vs the benchmark in their monthly fact sheets in a pre-specified format laid down by SEBI.

Generally, if a scheme’s returns are higher than the benchmark’s returns over the same period, the scheme is considered to be managed well. A significant point to note while comparing returns is that the scheme benchmark index values purely capture the underlying index portfolio returns. It does not have a component for expense ratio, while mutual fund schemes charge expenses.

To that extent, one can say that mutual fund scheme returns are net of expense ratio (as NAVs are adjusted for that) and benchmark returns do not have element of expense ratio. Investors should suitably account for this factor.

The other key factors leading to variance in return of schemes as compared to the benchmark are active management by the fund manager, inflows and outflows into the fund and cash levels.

Compare right

Investors need to exercise caution on account of three factors when comparing returns. Using benchmarks is akin to comparing apples with apples i.e., within the same asset class. Hence an equity benchmark cannot be used to evaluate performance of a debt scheme.

Benchmarks do not guarantee any absolute return. Even benchmark returns can be negative depending on market movements.

Outperformance/Underperformance against a scheme benchmark does not necessarily mean the scheme rank among the peers is best/worst. Peer group ranking is a separate exercise.

Checking scheme benchmark returns is one way to know how your fund is doing.

(The writer is Head – Fixed Income, Principal Pnb Asset Management Company. The article first appeared in The Hindu BusinessLine.)

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