Assess Your Portfolio’s Performance
A scheme’s benchmark is an index that is decided by its fund house to serve as a standard for the scheme’s returns. It tells you how a mutual fund has performed vis-à-vis its peers and the market.
In the year 2012, Capital market regulator SEBI (Securities and Exchange Board of India) has made it mandatory for fund houses to declare a benchmark index. This benchmark is independent and is based on the objectives of your fund.
In India, the BSE Sensex and the Nifty are the most widely followed benchmarks for large-cap funds. Examples of different market cap based benchmarks in BSE are BSE-100 index (representing the top 100 market cap stocks), the broader BSE-500 index, BSE Midcap Index (for midcap stocks), BSE Small Cap Index (for small-cap stocks), etc.
The stock exchanges also have sectoral indices representing different industry sectors. Examples of sectoral indices in BSE are BSE IT Index, BSE Pharma Index, BSE FMCG Index, etc. Hence, if you invest in a diversified equity fund that is benchmarked against the BSE Sensex, its return is compared with that of BSE Sensex.
Understanding Portfolio Performance With Respect To the Benchmark
When the market rises or falls, the fund will be impacted. Assume fund ABC is a diversified equity fund which is benchmarked against the Sensex. Thus, returns of fund ABC will be compared with those of the Sensex. If the Sensex rises by 12% over one year and the NAV of the fund rise only 6%, then it has underperformed its benchmark. If the fund does better than Sensex, it has outperformed the benchmark and vice-versa.
Now, if the Sensex declines 8% over one year and during the same period the fund’s NAV declines 6%, then the fund is said to have outperformed the benchmark.
One must note that if an actively managed fund delivers returns in-line with the benchmark, it should be considered as underperformance. This is because a professional fund manager has charged you a fee and only delivered returns equal to an index fund (a passively managed scheme that does not engage a fund manager).
Portfolio Performance – Outperformance & Underperformance
Let us understand in practical terms, what we mean when we say that, your fund should beat the market consistently. You cannot expect the fund manager to beat the market every month or even every quarter. Your fund manager aims to beat the market and as a result, will be overweight or underweight on certain sectors or stocks relative to the market index.
Therefore it will outperform the market in some months/quarters and under perform in other months/quarters. If your fund manager is able to beat the market consistently every year or even most years it should be considered good performance. Hence,
- Fund Performance > Benchmark, Outperformance
- Fund Performance < Benchmark, Underperformance
- Fund Performance = Benchmark, Underperformance
Measuring Portfolio Performance
Ascertaining whether a fund has outperformed is an important criterion while selecting a mutual fund. You can determine this looking over your fund’s historical returns.
The risk of a fund relative to the benchmark is measured by a metric known as Beta. If the beta of your fund is 1.10, you can expect 10% higher returns than the benchmark in an upward market, and 10% lower returns than the benchmark in a downward market.
A beta of 1 implies that your fund will fluctuate in sync with its benchmark. Within the same asset category (e.g. large cap funds) you will find funds with different betas. The beta will help you form return expectations. If beta is high, you can expect higher returns in up markets but also be prepared for more downside in corrections. The lower beta will reduce risk, but you should also expect lower returns.
Importance of Long-Term Portfolio Performance
When comparing a scheme with its benchmark, ensure that you consider the portfolio performance of the fund over 1 year, 3-year, 5-year and even 10-year returns (if the data is available). A funds ability to consistently outperform its benchmark is a highly desirable trait.
However, checking whether the fund has outperformed its benchmark is not the only criterion to select the scheme. But it is one of the important factors to invest in mutual fund schemes.
Note that past performance does not guarantee future returns. Hence, it is imperative to consult your financial provider and evaluate your risk appetite before making an investment.