What’s in the blog?
This blog breaks down the concept of benchmarking in mutual funds. It makes you understand why comparing your fund’s performance with the right index (and similar funds) is key to making smart investment decisions and how to actually do it without getting overwhelmed.
Table of Contents
Hey, remember that iconic line from 3 Idiots?
“Dost fail ho jaye toh dukh hota hai… lekin dost first aa jaye toh zyada dukh hota hai.”
That’s because, let’s admit it, we benchmark ourselves against our friends all the time. Whether it’s our own performance or our child’s, experts often say comparison is a bad thing. Honestly, I, too, have never liked being compared either.
But that’s real life with humans and their complex emotions. In the financial world, it’s a totally different game.
Here, comparison isn’t just helpful, it’s essential. If you don’t compare your mutual fund’s performance against a relevant benchmark, you may never know whether it’s truly doing well or just floating along.
So in this blog, let’s talk about how benchmarking works in mutual fund investing. I promise it’s not as technical as it sounds. By the end of this read, you’ll know exactly how to check if your fund is working for you.
But hey, keep the benchmarking limited to your investments, not your friends or kids. Deal?
Let’s dive in.
What is Benchmarking in mutual funds and Why Does it Matter?
See, investment is not just about ‘getting returns’. It is about getting ‘better returns’ for the risk you are taking. Suppose your fund shows a return of 8%. You’ll see it and feel content that your fund is growing, unless you get to know that the market index has given a 12% return in the same period.
When you see your fund performance in isolation, you might not know the real picture, as you would be hanging with just one number. Benchmarking helps you see the whole picture.
Here, it is important to understand that benchmarking is not comparing your fund with any random fund. We don’t compare apples to oranges. When you do benchmarking, you compare your mutual fund’s performance to a relevant market index like Nifty 50, Sensex, etc. Even when you want to compare your fund against a fund rather than an index, you compare it with a similar fund in the same category.
- Benchmarking helps you understand –
- If your fund is beating the market return
- If your fund is taking too much risk to gain a return
- If there are better-performing options available for you
How to Benchmark Your Funds: A Step-by-Step Guide
Now, you know benchmarking is important to ensure that your fund is working for you and working well. Now, let’s simplify the entire process for you.
Choose the Right Benchmark
As I said earlier, we don’t compare apples to oranges. The first step in benchmarking is to identify the right benchmark for comparison. If you have invested in a large-cap fund, you should compare it with the Nifty 50 or Sensex. If you are looking at the performance of a mid-cap fund, you can benchmark it against the Nifty Midcap 150.
The key is to compare like with like. This is because different sectors react differently to any given market condition. Large-cap, mid-cap and small-cap all perform differently in different time frames.
Check Historical Performance
It won’t be a wise decision to check the quarterly performance of your fund against a benchmark and switch it instantly if it is not beating the benchmark performance. You should look at 1-year, 3-year and 5-year returns. See if the fund is consistently beating or matching the benchmark, or if it is falling behind.
Consistency matters more than one good or bad quarter or year. Constant switching of funds is never recommended. So, you must ensure you have a substantial reason to do so.
Consider the Risk
For any market-related decisions, understanding the risk-to-reward ratio is very important. Your fund might be giving a 15% return while the benchmark gives 12%. It is necessary to inspect at what cost this return is being generated. If the fund is wildly volatile, it may give returns better than the benchmark in a bullish market, but the same fund can see a very sharp dip during a bear market.
You can use the Sharpe ratio or standard deviation to check your risk-adjusted returns. Low-risk risk-high high-return funds are what we should aim for.
Compare with Other Funds
Typically, benchmarking is understood as comparing a fund with an index fund. But comparing a fund with other funds in the same category is also something that will help you immensely. If you have invested in a large-cap mutual fund, you should see how other large-cap funds are performing.
If your fund is in the top quartile,i.e. top 25%, it is a positive sign.
My Take
Don’t compare your life journey with your neighbour’s. Your goals, your pace, your path… everything is different.
But do compare your mutual fund to its benchmark. Because that’s how you know if your money is truly doing justice to your goals.
And if you ever feel stuck while trying to understand your fund’s performance or wondering whether it’s time to switch, we’re here to help.
Just drop a comment or reach out, Team MoneyAnna would be happy to guide you through it.
Frequently asked questions (FAQ)
No. You need to look for consistent outperformance rather than just equal performance. If a mutual fund is giving the same return as its benchmark, it means the fund manager hasn’t really added any extra value. You might as well invest in a low-cost index fund that tracks the benchmark directly. The real appeal of an actively managed mutual fund lies in its ability to beat the benchmark after adjusting for risk and fees.
Ideally, you should not pick a mutual fund based simply on its benchmark performance. It can be the starting point for your research as it sets what kind of returns to expect. You should check the performance of the fund over time.
A mutual fund chooses its benchmark based on its investment objective and the types of stocks or assets it invests in. For example, a large-cap fund typically uses the Nifty 50 or Sensex as a benchmark because it primarily invests in large, well-established companies.
The benchmark for a hybrid fund depends on the type of hybrid fund and its equity-debt allocation. They typically use a composite benchmark that reflects the proportion of equity and debt they’re targeting. This ensures you’re comparing the fund’s performance with a balanced standard.
