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Financial Term of the week- Benchmark Index

The benchmark index for a particular mutual fund scheme is the index against which the scheme intends to measure its performance. For example, the NIFTY 50 index, which contains stocks of the companies that are ranked amongst the top 50 in terms of market capitalisation. This is the index against which many large-cap funds are benchmarked. In other words, the large-cap fund will try to match the performance of this benchmark. At times it may over perform, and at other times it may underperform the benchmark.

It mandatory for all mutual fund schemes to declare the index against which their performance is benchmarked. And rightly so, the scheme information document mentions the benchmark index of the mutual fund scheme.

What is an index?

To gain more perspective, let us understand what an index is. For example, in the case of equities, there is the stock exchange where all the stocks of various companies are traded. Now, there are thousands of such companies listed in the stock exchange, and it becomes difficult to track their performances. Hence, the stock market indices club the same kind of stocks together. This clubbing can happen on the basis of market capitalisation, as seen above, or even sector. The value of the group of stocks becomes the value of the index and as the former fluctuates, so does the latter.

Below are some common benchmarks for fund categories-

Fund Category Benchmark Index
Large-cap NIFTY 50 TRI/BSE Sensex TRI
Small-cap NIFTY small cap 250 TRI

Please note that the above indices are only examples of the benchmarks and not a comprehensive list.

How to use the benchmark to gauge a fund’s performance?

  1. Comparing a mutual fund scheme’s performance against its benchmark is only one of the ways to gauge the fund’s performance and in no way the only factor to consider.
  2. It is advisable to look at the long term returns of both the benchmark and the mutual fund scheme, when comparing.
  3. Always, measure the performance of the fund in question for at least 2-3 market cycles of ups and downs. That will give a fair idea of how the fund performs against the benchmark.
  4. While it is relevant that when the market is positive and indices are showing an upward growth, your fund should ideally do the same; the other very relevant thing is the downside performance. When the market is bear-ish, your fund should be able to hold its own and limit its losses vis-à-vis the benchmark. Hence, while the peaks are relevant, so is the extent of troughs.

In conclusion-

A benchmark index may help you in gauging the fund’s performance, but it is relevant to look at the more holistic picture. It is advisable to consider other measures of performance like alpha, beta, standard deviation also and then take a call. Please feel free to contact your mutual fund distributor for any further queries.

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