A few years ago, the regulator introduced standardization in investable stocks or bonds for each fund category. The objective was to reduce the unbridled flexibility in security selection practiced by funds within a category and to more align the fund portfolio with their chosen mandates. This ensures that the funds you invest in are largely in line with the mandate and your own risk tolerance. But the AMC is still allowed to choose the most suitable benchmark for each scheme. Benchmarks play a vital role in assessing the performance of an actively managed fund. These help the investor to assess whether the fund’s returns compare favorably with the relevant market benchmarks. But in the absence of a fixed benchmark or gauge, funds in the same category continue to benchmark the performance of different indices. This makes for uneven performance comparisons.
Multiple benchmarks for the same category make for uneven comparisons
CRISIL analysis of leading equity and debt-oriented schemes reveals that within a category the spread remains high in terms of benchmarking by the fund. For example, within large-cap funds, there are six unique benchmarks used by the underlying schemes. Similarly, there are seven unique benchmarks in the use of ELSS funds and Gilt funds. Corporate bond funds have eight unique benchmarks.
SEBI aims to address this by bringing more uniformity in the benchmarking system. Under the dual benchmark framework, open-ended mutual funds in both equity and debt categories will now have to adopt a primary benchmark in the form of a standardized index that reflects the broad fund category or mandate. Hence all flexi cap funds can now be benchmarked against a standard index like NSE Nifty500 or S&P BSE500. The relevant index will be collectively selected by the AMC and communicated to the regulator through AMFI. This will bring about uniformity in the comparison of performance of schemes within a single mutual-fund category.
In addition, funds will be allowed to adopt another ‘bespoke’ benchmark that reflects the investment style or strategy of the scheme. This benchmark will be optional and will be left to the discretion of the AMC. Its usefulness will extend beyond the primary index to enable investors to identify the specific strategy and style of the underlying scheme. For example, a large-cap oriented flexi cap fund may choose Nifty 200 Index Fund as its second benchmark to better reflect the risk-return profile of its target universe. At the micro level, this can facilitate the identification of schemes following a particular strategy within a broader category, in addition to better comparison of schemes running the same strategy within a category.
However, experts believe that the prudence to introduce a second benchmark may undo the benefits of having a single standardized index and create unnecessary confusion. Gaurav Rastogi, CEO of Kuvera, believes that it adds complexity to benchmarking which doesn’t help anyone. “If the selection of the second benchmark is left to the AMC, it may be used ambiguously by some of the AMCs. Some may resort to playing either of the two benchmarks interchangeably depending on the market conditions,” he says. Vidya Bala, Head of Research, PrimeInvestor.in argues that this option leaves open ground for AMCs to offer custom-built indices to show relative performance. It is also possible that two funds following the same style or strategy may adopt different indexes for use as ‘bespoke’ benchmarks.
Most experts say investors need not look beyond the mainstream broad indices. The primary benchmark—reflecting the category’s mandate—should be sufficient by itself to aid in performance appraisal. Bala called upon the investors not to get distracted by the new bespoke indices. “As an investor, you only expect your fund to outperform the market over time. Broad market indices are enough to facilitate this comparison,” she says. If at all, only the second benchmark should be considered. The style can be referred for a deeper analysis of divergence. Debt funds can do without any benchmark comparison. Bala emphasized that given the similarity of debt funds in the same category, these are subject to peer-to-peer comparisons. are more suitable for
However, not all funds will have a two-tier benchmark. Thematic and sectoral funds as well as index funds and ETFs will have a single benchmark. Hybrid and solution-oriented schemes will facilitate a single benchmark based on broad market benchmarks, wherever available. Otherwise, a specific benchmark will be created, which will then be applicable to all funds in the category. In case of Fund of Funds (FOF), the benchmark of the underlying scheme will be used for schemes investing in a single fund, while a broad market index will be used for FoF investing in multiple schemes.