Sharekhan Blog

What is Benchmark In Mutual Fund?

  • Apr 1, 2024

However, it's possible that you were unaware of the meaning of a "mutual fund benchmark" or how it affected the amount you invested. Let's take a closer look at the benchmark in mutual fund means in this post.

Benchmark in Mutual Funds Meaning

An index called a benchmark is used to assess the overall performance of mutual funds. It offers a ballpark estimate of the expected return on an investment, which can be contrasted with the actual return. A mutual fund's goal should ideally be to equal the return of its benchmark.

Typically, fund houses choose the benchmark index for a given investment. It is regarded as the foundational criterion for the scheme's return. Benchmarking data for small-cap, mid-cap, and large-cap equity funds is available from a number of fund firms in India. These include indices such as Sensex, BSE 200, NIFTY, CNX Midcap, Smallcap, etc.

For any kind of investment choice in India, a benchmark index declaration is required. This rule is applied to the financial market by SEBI, the Securities and Exchange Board of India.

Importance of Benchmark in Mutual Funds

We must compare the performance of the funds to the benchmark in order to comprehend the significance of the benchmark in mutual funds.

1. The output that benchmark mutual fund provides will provide you with a quality benchmark so that you may compare. It facilitates your comprehension of the fund's earnings and its expected returns.

2. Benchmark gives investors the chance to assess how their investment stacks up against the overall market. The fund house often sets out to outperform the benchmark index.

A chosen fund with identical stocks may outperform a particular benchmark. We refer to these differences as volatility. Investors can only gain a better understanding of this by looking at the fund's performance standard deviation.

How to Use the Benchmark to Gauge a Fund’s Performance?

There are numerous techniques to measure fund performance. The first that springs to mind is alpha, or the excess return that a mutual fund has produced over that of its benchmark. However, beta, which gauges a fund's sensitivity to the market or its benchmark in the context of mutual funds, is another performance metric. Market volatility is commonly expressed as a number between 0 and 1, where 1 represents the benchmark's volatility. More stability is found in mutual funds with volatility under 1 compared to their benchmark index.

When comparing a mutual fund to its benchmark, there are other factors to consider. Among them are:

1. Rather than focusing on short-term gains, one should compare the mutual fund and its benchmark mutual fund based on its long-term performance.

2. Observing the returns over two to three market cycles is a wise technique to assess a mutual fund along with its benchmark. This will give you an idea of the fund's performance, both upside and downside.

3. Additionally, it will immediately contextualise the market's returns inside the performance of the fund.

4. The market, mutual funds, and indexes all move in both directions. Measuring a market's troughs or bear phases is just as crucial as determining the size of the peaks that develop on charts during a market's bull phase.

5. The standard deviation, which represents the difference in a mutual fund's return relative to its average return, is a useful metric for assessing the fund's performance during several market cycles.

How Do You Evaluate Benchmark Performance?

When assessing benchmark performance, the following elements should be taken into account:

1. Duration

It is recommended that the mutual fund's performance be compared with the benchmark performance within the same time frame. This will give an accurate evaluation of the fund's performance in comparison to its benchmark.

2. Fund Goals

The benchmark ought to be in line with the mutual fund's goals and investment approach. A fund that invests in small-cap stocks, for instance, should have a benchmark that reflects the performance of small-cap stocks.

3. Regularity

A good benchmark needs to be well recognised and constant in the sector. This guarantees that the market or industry it is tracking is appropriately reflected.

4. Performance Adjusted for Risk

It is crucial to evaluate the risk-adjusted performance of a fund in relation to its benchmark. This offers a more accurate performance indicator by accounting for the degree of risk assumed to generate profits.

The Bottom Line

In the context of mutual funds, a benchmark is a point of reference that helps investors assess their investments and measure performance. It is decided upon in accordance with the fund's goals and is subject to modification. Mutual funds use a variety of benchmarks, and it's important to assess them correctly by taking into account things like consistency, time horizon, and risk-adjusted performance.

In the end, a benchmark should not be the only consideration when selecting a mutual fund; however, it can be a useful tool when making investment decisions.

Team Sharekhan
by Team Sharekhan

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