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Benchmarking – Comparing with Market Index

Introduction

"How do I know if my fund is doing well?" A return of 10% sounds good, but what if the general market is up by 20%? In that case, your fund has actually underperformed. To solve this, every mutual fund must declare a Benchmark Index against which its performance will be compared.

1. What is a Benchmark?

A benchmark is a standard index (like Nifty 50 or Sensex) that represents the "market" for a specific category of funds.

  • Purpose: To provide a reference point to judge whether the Active Fund Manager is adding any value.
  • Passive Alternative: Since you can buy the Nifty 50 via an Index Fund or ETF for very low cost, an Active Fund collecting high fees MUST beat the Nifty 50.

Common Benchmarks

  • Large Cap Funds: Nifty 100 TRI or S&P BSE 100 TRI.
  • Mid Cap Funds: Nifty Midcap 150 TRI.
  • Tax Saver (ELSS): Nifty 500 TRI.
  • Liquid Funds: CRISIL Liquid Fund Index.

2. The Concept of Alpha

Alpha is the excess return generated by the fund manager over and above the benchmark.

Equation:

Alpha = Fund Return - Benchmark Return
  • Scenario 1: Nifty 50 gives 12%. Fund A gives 15%.
    • Alpha: +3% (Excellent job by manager).
  • Scenario 2: Nifty 50 gives 12%. Fund B gives 10%.
    • Alpha: -2% (Manager failed; investor lost money compared to passive investing).

3. Total Return Index (TRI) - The New Standard

Since 2018, SEBI has mandated that all mutual fund performance must be compared against the Total Return Index (TRI).

PRI vs TRI:

  • Price Return Index (PRI): Only captures the rise in stock prices (e.g., Nifty moves 10,000 to 11,000).
  • Total Return Index (TRI): Captures the rise in stock prices PLUS the dividends paid by the companies in the index.

Why TRI matters: Dividends add about 1-1.5% extra return per year. Comparing a fund (which reinvests dividends) against a PRI (which ignores dividends) gave an unfair advantage to funds. TRI makes the comparison fair and "apple-to-apple."

Comparison: Fund vs Benchmark

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Exam Notes: Writing the Answer

Question: "What is Benchmarking in Mutual Funds? Explain the concept of TRI." (10 Marks)

Model Answer:

Benchmarking: It is the practice of comparing a mutual fund scheme's performance against a standard market index (e.g., Nifty 50) to evaluate the fund manager's skill.

  • Requirement: SEBI mandates every scheme to declare a benchmark.
  • Alpha: The positive difference between Fund Return and Benchmark Return is called Alpha.

Total Return Index (TRI): Historically, funds compared returns against the Price Return Index (PRI), which ignored dividends.

  • Since Feb 2018, SEBI made TRI mandatory.
  • TRI = Capital Appreciation (Price Rise) + Dividend Yield.
  • This ensures a stricter and tougher comparison for fund managers, ensuring they truly earn their fees by beating the full market return (Price + Dividend).

Summary

  • Benchmark: The "Pass Mark" for a fund.
  • Alpha: Excess return over benchmark.
  • TRI: Includes Dividends. Mandatory for fair comparison.
  • Verdict: If a fund consistently fails to beat its benchmark (Negative Alpha), investors should switch to a low-cost Index Fund.

Quiz Time! 🎯

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