Mutual Fund Benchmark| North Loop Official Blog
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27 Oct 2020

Mutual Fund Benchmark

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What is a benchmark in mutual funds?

Benchmark in mutual funds means an index that gets used to measure how much a fund has earned against how much it should have. It is essentially a performance indicator for mutual funds and helps to ascertain whether the returns of a mutual fund are up to the mark or not. Ideally, mutual funds target a benchmark return, and if it manages to beat it, it gets considered to be performing well. Benchmark meaning in mutual fund can get best defined by giving examples of the Bombay Stock Exchange (BSE) Sensex and the National Stock Exchange (NSE) Nifty that are well-known benchmarks in India and invest in various company stocks. Also, the Securities and Exchange Board of India, SEBI, has made the declaration of a benchmark index as a mandatory requirement for all types of investment options in India. Now that you know benchmark meaning in mutual fund, let us understand the importance of benchmark mutual funds.

Importance of benchmarking in mutual funds -

’Benchmark in mutual funds’ means providing an established platform to compare returns. That means if an equity fund gets benchmarked against Sensex, its return can get compared with the performance of Sensex. Fund houses select these benchmarks indices based on factors like thematic strategies of that particular investment or its market capitalization. As a usual thumb rule, benchmark mutual fund performanceis considered in a manner wherein, funds that outperform provide better returns than the benchmarking value whereas those that underperform give lesser returns than their benchmark values.

The different types of benchmarking indices available for the various funds can prove to be extremely beneficial as they offer a clear understanding of the portfolio and performance of these funds. It can also enable you to make suitable decisions depending on their return expectations. Usually, large-cap funds are appropriate if you have a lower risk appetite whereas small and mid-cap for higher risk appetite.

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Benchmark index mutual funds for a portfolio usually get created based on a few factors -

Risk profile - Benchmark mutual fund models get primarily based on several factors that determine your risk profile.

Asset allocation - An overall asset allocation model gets created to select the suitable benchmark index mutual funds based on your risk tolerance level. The allocation gets done either by using sizeable indices or by dividing the entire value into small or mid-sized indices. For the best portfolio management, it becomes crucial to use appropriate benchmarking.

How to measure mutual fund performance against a benchmark?

In the case of comparing benchmark mutual fund performance and gauging whether the funds have delivered a higher return than the benchmark or not, it is best to analyze the return offered by the fund and its NAV. If the return exceeds the benchmark, the funds get considered to have outperformed and vice versa. Also, sometimes the benchmark index records a consistent fall and the NAV of the fund experiences the same but at a lower percentage. Such funds also get considered to have outperformed the benchmark.

Financial Ratios -

Several ratios get used for evaluating the performance of mutual funds. These get based on different types of benchmarking indices depending on large, small or mid-cap funds. Some of the popular ones are as follows -

Alpha - Alpha helps in calculating the difference between the expected and the actual return of a particular mutual fund. It also gets used to determine the value addition of a fund managers performance. This financial ratio is primarily useful for calculating the excess returns generated by a fund after taking into consideration its risk factor.

Beta - Beta determines the risk associated with a particular fund with regards to the benchmark. A fund gets considered to be more volatile if its Beta value is more than one and vice versa. Beta values are primarily used as a measure of expected returns and help in calculating the same after consideration of the risks associated with the market.

R-squared - R-squared is a number between 0 and 100 and gets used to measure the percentage of an asset or mutual fund’s performance. For example, if a mutual fund has an R-squared value of 0, then it does not correlate its benchmark to any degree while if it has a value of 100, then it is considered to match it exactly.

Conclusion -

Benchmarks prove to be a beneficial tool to measure a fund’s potential based on past performance, but they do not always guarantee the best results. That is the reason financial advisors suggest that you should understand your risk profile well and evaluate your needs before making any investment decisions.

If you are interested in investing in mutual funds, you can do so via North Loop. We offer a digital investment platform with personalized recommendations, professional support as well as investment tracking facilities to ensure you have a smooth and easy investing experience.

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This publication is provided for general information purposes only and is not intended to cover every aspect of the topics with which it deals. It is not intended be advice. You must obtain professional advice before taking, or refraining from, any action on the basis of the content in this publication. The information in this publication does not constitute legal, tax, investment or other professional advice from North Loop or its affiliates. We make no representations, warranties or guarantees, whether express or implied, that the content in the publication is accurate, complete or up to date. All opinions expressed do not reflect the views of North Loop nor are endorsed by North Loop.