Understanding the Significance of Benchmarks in Mutual Funds

When you venture into the world of mutual funds, you may often come across the term 'benchmark,' but you might not fully comprehend what it entails and how it impacts your investments. In this article, we delve into the concept of benchmarks in mutual funds to provide you with a clear understanding.

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What Is a Benchmark?

A benchmark is essentially a standard used to evaluate the performance of a mutual fund scheme. It serves as an indicator of the returns that your investment should ideally generate. This figure can be compared against the actual returns your investment has achieved.

?In 2012, SEBI mandated that fund houses must declare a benchmark index for every scheme. Ideally, a mutual fund's aim should be to match or surpass the returns of its benchmark.

Typically, mutual fund houses establish the benchmark for a specific investment, and this benchmark becomes the baseline standard for that mutual fund scheme.

Below, you can find some mutual fund schemes along with their respective benchmarks:

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Scheme Name Benchmark

1.?????? Mirae Asset Large Cap Fund NIFTY 100 Total Return Index

2.?????? Axis Bluechip Fund NIFTY 50 Total Return Index

3.?????? Canara Robeco Bluechip Equity Fund S&P BSE 100 Total Return Index

4.?????? SBI Bluechip Fund S&P BSE 100 Total Return Index

5.?????? Tata Large Cap Fund S&P BSE Sensex Total Return Index

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The Role of Benchmarks in Mutual Funds

For investors in mutual funds, fund managers are entrusted with the task of managing their money. Benchmarks play a pivotal role in enabling investors to gauge how effectively their funds are being managed over time. If a particular mutual fund scheme consistently generates higher returns than its benchmark index, it is considered to be performing well.

Financial experts assert that if the performance of a mutual fund scheme is equal to or falls below that of the benchmark index, it indicates that the fund manager is underperforming. In such cases, the fund manager should strive for better performance, aiming to outperform the benchmark index.

However, if the returns closely mirror those of the benchmark index, it's possible that the investor is essentially investing in the index, negating the fees paid to the fund manager. When a fund manager consistently delivers returns above the benchmark over time, it tends to boost demand for that fund.

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The Importance of Benchmarks in Mutual Funds

To grasp the significance of benchmarks in mutual funds, one must compare a fund's performance to its benchmark.

1. The benchmark's return serves as a benchmark itself, providing a standard against which you can evaluate the fund's performance. It helps you discern whether the fund has met or exceeded your expectations.
2. Benchmarks offer investors the opportunity to compare their investments with the broader market. Typically, fund houses set the goal of outperforming the benchmark index.
3. It's important to note that selected funds with the same stocks might outperform a given benchmark. These discrepancies are known as volatility. To understand this better, investors can examine the fund's performance by looking at its standard deviation.

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How Benchmarks Work in Mutual Funds

According to some financial experts, investors should focus on absolute returns, which represent the actual returns their investments have garnered. Returns from the equity market are often volatile, fluctuating between high and exceptionally low returns. What truly matters is whether your returns consistently outperform the market, instilling confidence in your ability to meet your investment goals.

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Here are some key considerations:

1. Long-term investment horizons vary among investors. Some may have a 3-year horizon, while others may look at a 10-year timeline. The choice of fund category should align with your investment timeline, and the benchmark will vary accordingly.
2. Be realistic in your expectations; fund managers cannot be expected to outperform the stock market every month. Their goal is to surpass the benchmark over a reasonable period.
3. Your invested fund may not use the broader market index as its benchmark. If, for instance, the Nifty index rises, you shouldn't necessarily expect your investment to follow suit, especially if you've invested in a different category with its own benchmark.
4. Moreover, when evaluating mutual fund performance, carefully review the fund's portfolio to ensure that the benchmark is appropriate based on the information provided in the document and factsheet.

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Benchmarking Ratios Used by Fund Houses

Fund houses also employ ratios to assess mutual fund performance, and these ratios are often benchmarked against specific indices depending on the fund's category—large, mid, or small-cap funds. Here are a few key ratios:

1. Alpha: This form of investment involves passive management, with the portfolio not frequently adjusted. Investors are aware of the investment mandate, which follows predefined guidelines.
2. Beta: Beta quantifies the risk associated with a mutual fund scheme concerning its benchmark index. If a scheme's beta is less than 1, it signifies lower risk compared to its benchmark, and vice versa.
3. R-squared: R-squared measures a mutual fund scheme's performance influenced by its benchmark. It ranges from 0 to 100, with 0 indicating the lowest correlation and 100 indicating an exact correlation.

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Conclusion

Understanding and comprehending benchmarks in mutual funds is crucial, especially for first-time mutual fund investors. If the funds in which you've invested consistently outperform their market benchmarks despite market fluctuations, it increases the likelihood of achieving your investment objectives.

At SIP Fund, we simplify the complex world of mutual funds and benchmarks, helping you navigate this vital aspect of investing. Our experts provide clarity on how benchmarks impact your investments and guide you towards making informed decisions.

Reach out to us at [email protected] or call +91 9513355661/62/63/64 for personalized assistance in understanding and leveraging benchmarks for your financial success.

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