What is a benchmark index?

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Recently there was a report that most of the midcap and smallcap funds have performed superbly. However they still lagged benchmark. If a fund is performing well then what does this benchmark mean? Most of the mutual fund investors don’t even know about what is the benchmark for specific mutual fund.

Markets regulator SEBI has made it mandatory for mutual funds to tell the benchmark name for each of their mutual fund. So, let’s understand what is benchmark.

A benchmark, also called an index, is a group of securities whose prices are based on the current market price. The benchmark is worth the same as the sum of the prices of its securities as per a specific formula. For example, BSE Sensex is an index which has 30 shares. The price of the benchmark changes when the prices of its securities change.

Benchmark returns are a valuable tool for useful comparison since they indicate how much your fund performed vs how much it should have earned.

If a Sensex has given a 10% return in a year, then we will see whether funds having similar share composition have earned more than 10% or less than 10%. If a fund is giving a higher return, then it will be considered good.

The fund house determines the benchmark index for the scheme. The BSE Sensex and the NSE Nifty are well-known benchmarks for investing in shares of  large companies.

SEBI stated that As of February 1, 2018, the Total Return Index (TRI) would be the new benchmark. The TRI considers both capital gains and dividends when figuring out returns.

For instance, all benchmarks have the word TRI, Benchmark: S&P BSE 100 Total Return Index (TRI), S&P BSE 100 Total Return Index (TRI), S&P BSE PSU Total Return Index (TRI).

The average equity large cap is still below the returns of its benchmark S&P BSE 100 Total Return Index. On the other hand, equity value oriented mutual funds have performed better than its benchmark S&P BSE 100 Total Return Index.

Now the question is how important is a benchmark for investors? As per financial experts, a benchmark is most important factor when you look to invest in a mutual fund. But not the only one.

Shweta Jain, CFP, founder of Investography says “Comparing against benchmarks is a good indicator of how the scheme is doing. Is the scheme in line with the benchmark it’s setting, and is it following its scheme purpose/intent”.

However, investors should keep in mind that benchmark is not the only parameter. Look at fund performance, fund manager, risk appetite and various other factors.