Whenever you are trying to gauge whether a fund is good enough to invest in or to stay invested, it is a good idea to compare it with its peers. But, if you have a reference point to compare it against, you can be sure that your fund is good enough. This reference point is commonly known as a benchmark.

You cannot compare equity mutual funds with debt mutual funds because of obvious reasons. Equity mutual funds are for aggressive investors whereas debt mutual funds are for conservative investors. Equity can give you returns around 11% – 15% whereas debt can give you returns of around 7% – 9%. Equity, debts, balanced, and gold are very broad classifications.

When you look at equity itself, there are large cap funds, multi cap, small cap, and sector-specific funds like pharmaceuticals, technology, banking etc. The underlying securities and the proportion in which they are bought is what defines a fund category and so you can expect similar returns from two funds that fall into the same category.

Here is an example to show how a fund is compared with its benchmark. For example, the fund is HDFC Mid Cap Opportunities fund and the benchmark against which it is compared is Nifty Free Float Mid-Cap 100. The category in which this fund falls is Equity Mid-Cap. When you compare 2 funds, just be sure that they fall into the same fund category. You should not compare fund with the ‘category returns’ or ‘risk returns’ parameters because the category values are an average of all the funds in that particular category which would include the best performing and the least performing, and so it is better to compare your fund with the top 5 funds within the category rather than comparing it with the values of the category. The fund beats its benchmark on three year trailing returns, P/E ratio, standard deviation, alpha, and Sharpe ratio. This is how you can be sure in one shot that your fund is definitely doing well. This performance has to be consistent and when you know that your fund is beating its benchmark, you can go ahead and compare it with its peers.

You must be wondering why you cannot compare HDFC Mid Cap Opportunities fund with a simpler index like the Nifty or Sensex. Nifty is made of 50 stocks whereas Sensex is made up of just 30 stocks and equity mutual fundson an average hold around 80 stocks. Comparing 80 stocks with just 50 or 30 would not be fair. You simply need a broader index. Various indices exist which suit various categories. You can find such a list on Nifty or Sensex website. Also, since 2012, SEBI (Securities Exchange Board of India) has made it mandatory for mutual funds to declare the index they have benchmarked against.

So the next time you see an ad where the fund is boasting about the kind of returns it has earned for its investors, just compare the returns against its benchmark and you would know whether the claims are legitimate or not. Now you know what a benchmark and a category are and how to use these when you analyze your fund.

Some stock market indices used in India are:

  • Broad market indices include BSE 500 and BSE 100
  • Sectoral indices include BSE Bankex and CNX IT
  • Market capitalization indices like BSE Midcap and BSE Smallcap
  • Benchmark indices include NSE Nifty and BSE Sensex

With accurate knowledge of indices, you can actually track the performance of your mutual fund investment. You will take better decisions regarding which mutual fund to invest in, when to stay invested and when to pull out the investment.

By rawat