If a mutual fund’s one-year return drops 7.5% would it be right to say that the fund performed badly? It would be fair to compare the fund’s performance to a standard. So, a  standard is thus the fund’s benchmark that helps to facilitate understanding of  any performance.

What is a benchmark?

It is important to understand the significance of using a benchmark for the purpose of effective comparison. Since 2012, for the sake of standardisation, Sebi (Securities and Exchange Board of India) has made it mandatory for fund houses to declare a similar return in INR and by way of CAGR, in addition to the scheme benchmark performance.
A scheme’s benchmark is an index that is decided by its fund house to serve as a standard for the scheme’s returns.

The BSE Sensex and Nifty are the most generally used benchmarks in India for mutual fund investments. Other benchmarks are Nifty 500, Nifty 100, CNX Midcap, CNX Smallcap, S&P BSE 200 etc.  Investors are given an opportunity to compare the performance of their investments with that of the broader market. Suppose you are investing in a diversified equity fund that is benchmarked against the BSE Sensex.

Its returns are thus compared with that of BSE Sensex. Hence a large-cap fund’s performance needs to be compared against a large-cap benchmark and vice-versa. Once you know the performance, you can decide whether to enter or exit a mutual fund.

Performance of mutual funds

A mutual fund gets hit with force whenever the market scales new heights or comes crashing down. Let’s take for instance a diversified equity fund – Fund A is benchmarked against the Sensex. Its returns are compared with that of the Sensex. Now suppose the fund achieved 40% returns though the Sensex earned 50% returns, it would mean that Fund A underperformed its benchmark.

While on the other hand, if the fund achieved 50% returns and the Sensex generated only 30%, it would mean that Fund A outperformed its benchmark. There are some situations where a fund generates similar returns as that of its benchmark. Such cases are said to be considered as fund under-performances as the main intent of actively managed equity mutual fund investing is to perform better than the benchmark.

– Quantum Mutual Fund