NISM V-A Chapter 11 Notes: Mutual Fund Scheme Performance Explained

Benchmarks and Performance : 

  • Benchmark Definition: Benchmarks help evaluate mutual fund scheme performance by providing a comparable standard. 
  • Criteria for Credible Benchmark: It must align with the scheme’s investment objective, asset allocation, and strategy. 
  • Benchmark Construction: Should be independently and transparently calculated, typically by stock exchanges, rating agencies, or financial media. 
  • Index Fund Benchmarks: Selection is straightforward, as the tracked index naturally serves as the benchmark. 
  • Other Schemes: Benchmark selection is subjective and decided by the AMC with trustee consultation; disclosed in the Scheme Information Document. 
  • Benchmark Changes: Permitted if justified (e.g., change in investment objective or availability of better index) and require trustee approval and proper documentation. 
  • Learning Objectives: Cover benchmark concepts, selection criteria, performance indices, and sources for tracking and disclosing fund performance. 

Price Return Index or Total Return Index : 

  • Earlier, mutual fund schemes were benchmarked to the Price Return Index (PRI), which only reflected capital gains. 
  • Since February 1, 2018, schemes are benchmarked to the Total Return Index (TRI), which includes both capital gains and dividends/interest. 
  • The shift to TRI ensures fairer performance comparisons, as mutual funds earn dividends too. 
  • Under the dividend option, performance is measured using the reinvestment method, making comparison with PRI biased. 
  • TRI adoption enhances transparency and shows fewer schemes beating the benchmark, although actual performance hasn’t changed. 
  • The difference between PRI and TRI returns reflects dividend yields, typically 1.5% to 2.5% in Indian markets. 

Basis of Choosing an appropriate performance benchmark : 

  • Benchmark selection must align with a mutual fund scheme’s investment objective, asset allocation, and strategy. 
  • SEBI mandates benchmarking scheme performance to the Total Return Index (TRI) of the selected benchmark. 
  • If TRI data is unavailable, a composite CAGR using PRI and TRI should be used. 
  • Details on these requirements are outlined in SEBI Circular No. SEBI/HO/IMD/DF3/CIR/P/2018/4. 
  • All necessary scheme details can be found in the Scheme Information Document. 

Benchmarks for equity schemes : 

  • Scheme Type: Diversified funds use broad indices (e.g., Nifty 50, BSE 500) as benchmarks; sectoral/thematic funds use sector-specific indices (e.g., BSE Bankex). 
  • Investment Universe: Large-cap funds benchmark against indices like Sensex and Nifty 50; mid-cap funds use indices like Nifty Midcap 50 or BSE Midcap. 
  • Portfolio Concentration: Funds with fewer stocks prefer narrow indices (e.g., Sensex, Nifty 50); those with broader portfolios use wider indices (e.g., Nifty 100/500). 

Benchmarks for Debt Schemes : 

  • SEBI Guidelines: Debt and balanced scheme benchmarks must be developed by AMFI-recommended research/rating agencies like CRISIL, ICICI Securities, and NSE. 
  • NSE Indices: Includes Nifty composite G-sec index, Nifty 4–8 Year G-sec index, and Nifty 10-year benchmark G-sec index for government securities. 
  • BSE Indices: Offers benchmarks like the S&P BSE India Sovereign Bond Index and S&P BSE India Government Bill Index. 
  • ICICI I-Bex Series: Covers government securities with an umbrella index and sub-indices—Si-Bex (1–3 yrs), Mi-Bex (3–7 yrs), Li-Bex (7+ yrs). 
  • CRISIL Indices: Provides specific indices for various debt scheme categories like Overnight Fund (CRISIL Overnight Index), Liquid Fund, Corporate Bond Fund, etc. 
  • Benchmark Selection: Depends on scheme type and investment universe; e.g., liquid funds use short-term indices, while gilt funds use government securities indices. 

Benchmarks for Other Schemes : 

  • Hybrid Funds: Benchmarks are blended indices combining debt and equity in scheme-specific ratios (e.g., 65% Sensex + 35% I-Bex). CRISIL provides ready indices for Aggressive, Balanced, and Conservative Hybrid Funds. 
  • Gold ETFs: Benchmarked against gold prices. 
  • Real Estate Funds: Use indices from real estate services firms, though these lack broad acceptance. 
  • International Funds: Benchmarks depend on targeted markets (e.g., Shanghai Composite for China, S&P 500 for the US). Multi-country funds may use blended indices. 
  • Standardized Benchmarks: SEBI mandates schemes report returns in INR and CAGR against standard benchmarks (e.g., Sensex/Nifty for equity schemes, 10-year GoI security for long-term debt). 
  • SEBI’s Two-Tier Benchmarking (from Jan 2022)
  • Tier-1: Broad Market Index reflecting the scheme category. 
  • Tier-2: Bespoke Index based on fund manager’s style/strategy. 
  • Special Cases
  • Thematic, Sectoral, Index Funds, and ETFs use a single benchmark relevant to their focus. 
  • Fund of Funds (FoFs) use the underlying scheme’s benchmark or a broad market index for multi-scheme investments. 

Quantitative Measures of Fund Manager Performance : 

  • Relative Return Comparison: Compares scheme returns to benchmarks or peers to judge fund manager performance, but doesn’t account for differing risk levels. 
  • Risk-Reward Evaluation: More accurate by relating returns to risks taken, using Risk-Adjusted Returns
  • Sharpe Ratio
  • Measures excess return per unit of total risk (standard deviation). 
  • Higher Sharpe = better. 
  • Should only compare similar fund types. 
  • Treynor Ratio
  • Measures excess return per unit of market risk (beta). 
  • Higher Treynor = better. 
  • Relevant mainly for diversified equity funds. 
  • Alpha
  • Measures performance over expected return based on beta. 
  • Positive alpha = outperformance, negative = underperformance. 
  • Best suited for diversified equity schemes. 
  • Caution
  • These are historical metrics and not guarantees. 
  • Quantitative results need expert qualitative interpretation. 

Tracking Error : 

  • The market’s Beta is 1, and an index fund, which mirrors the market, also has a Beta of 1. 
  • Tracking error is the difference between an index fund’s return and the market return. 
  • Initially, it measured how closely an index fund followed its benchmark, aiming for zero tracking error. 
  • Now, it assesses how consistently a fund outperforms its benchmark. 
  • Tracking error is calculated as the standard deviation of a fund’s excess returns over its benchmark. 
  • low tracking error indicates consistent outperformance by the fund. 
  • Beta measures a stock’s volatility relative to the market: 
  • Beta > 1 = More volatile, higher risk & potential returns 
  • Beta < 1 = Less volatile, lower risk & returns 

Scheme Performance Disclosure : 

  • SEBI Mandate: Asset Management Companies (AMCs) must disclose scheme performance data via Scheme Information Documents (SID) updated annually, and through fund websites. 
  • Fund Factsheets: Published monthly (though not mandatory), factsheets summarize scheme objectives, performance, portfolio details, and fund manager views on markets and economy. 
  • Access Points: Scheme data is available through SIDs, factsheets, mutual fund portals, and AMFI’s website. Third-party data vendors also offer NAV, dividend, and performance data. 
  • Product Literature: Includes scheme suitability, return performance, and portfolio details to help investors assess schemes’ alignment with their goals and risk appetite. 
  • Key Metrics in Factsheets
  • Market indices and yields 
  • Corporate earnings and sectoral analysis 
  • Government spending and fiscal trends 
  • Inflation and interest rate impacts 
  • Domestic and foreign portfolio investor activity 
  • GDP growth and global economic indicators 
  • Commodity, raw material, and labor price trends 
  • Purpose of Disclosures: To enable investors and distributors to track scheme performance, market conditions, and economic trends for informed investment decisions. 
  • AMFI Website: Hosts exhaustive, period-wise mutual fund performance data, accessible to investors and distributors. 
  • Third-party Agencies: Data vendors like Morningstar and Value Research offer performance data and analysis tools, though users must assess their suitability independently. 

Leave a comment