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.
- A 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.