CHAPTER 11: MUTUAL FUND SCHEME PERFORMANCE – 7
Marks
11.1 Benchmarks and Performance
Benchmarks
Mutual fund schemes invest in the market for the benefit of Unit-holders. How well did a
scheme perform? An approach to assess the performance is to pre-define a comparable
benchmark against which the scheme can be compared.
• A credible benchmark should meet the following requirements: It should be in sync
with (a) the investment objective of the scheme (i.e., the securities or variables that go
into the calculation of the benchmark should be representative of the kind of portfolio
implicit in the scheme’s investment objective); (b) asset allocation pattern; and (c)
investment strategy of the scheme.
• The benchmark should be calculated by an independent agency in a transparent
manner, and published regularly. Most benchmarks are constructed by stock
exchanges, credit rating agencies, securities research houses or financial publications.
The choice of benchmark is simplest for an index fund. The investment objective is clear on
the index that the scheme would track. That index would then be the benchmark for the
scheme.
For other schemes, the choice of benchmark is subjective. The benchmark for a scheme is
decided by the AMC in consultation with the trustees. The Scheme Information Document
has to mention the benchmark. Further, along with the past performance of the scheme, the
performance of the benchmark during the same period has to be mentioned. At a later date,
the fund may choose to change the benchmark. This could be for various reasons. For
instance, the investment objective of the scheme may change, or the construction of the
index may change, or a better index may become available in the market. AMCs can change
the benchmark in consultation with the trustees. Further, the change needs to be justified and
documented. Mutual fund schemes are required to disclose the name(s) of benchmark
index/indices with which the scheme's performance is compared.
11.2 Price Return Index or Total Return Index
Earlier, the Mutual Fund schemes were benchmarked to the Price Return variant of an Index
(PRI). PRI only captures capital gains of the index constituents. With effect from February 1,
2018, the mutual fund schemes are benchmarked to the Total Return variant of an Index (TRI).
The Total Return variant of an index takes into account all dividends/interest payments that
are generated from the basket of constituents that make up the index in addition to the
capital [Link] a change was required to ensure that the performance comparison is fair.
The scheme The shift to TRI has been another one in the direction of increasing transparency
1
of mutual funds.
In other words, this would make it appear that fewer schemes are able to beat their
benchmark indices. While the reality has not changed, the presentation of the same has
changed. The gap between the returns between PRI and TRI is the amount of dividend.
Historically, in the Indian markets, the dividend yields at the index levels have ranged between
1.5 percent to 2.5 percent, most of the times.
11.3 Basis of Choosing an appropriate performance benchmark
The selection of the benchmark for performance comparison must also be done keeping
these in mind. With an objective to enable the investors to compare the performance of a
scheme vis-à-vis an appropriate benchmark, SEBI has mandated: 113
• Selection of a benchmark for the scheme of a mutual fund to be in alignment with the
investment objective, asset allocation pattern and investment strategy of the scheme.
• The performance of the schemes of a mutual fund to be benchmarked to the Total
Return variant of the Index chosen as a benchmark.
• Mutual funds should use a composite CAGR figure of the performance of the PRI
benchmark (till the date from which TRI is available) and the TRI (subsequently) to
compare the performance of their scheme in case TRI is not available for that
particular period.
Thus, the scheme’s benchmark must be chosen based on Scheme’s investment objective,
Investment strategy of the scheme, and the scheme’s asset allocation pattern. All the three
can be seen in the Scheme Information Document.
11.4 Benchmarks for equity schemes
The following aspects of the investment objective (scheme type, choice of investment
universe, portfolio concentration, underlying exposure) drive the choice of benchmark in
equity schemes.
Scheme Type
A sector fund would invest in only the concerned sector; while there are some funds that
invest in all sectors. Therefore, funds investing in different sectors need to have a diversified
index as a benchmark index, like S&P BSE Sensex or Nifty 50 or S&P BSE 200 or S&P BSE 500
or Nifty 100 or Nifty 500 as a benchmark; sectoral/thematic funds select sectoral/ thematic
indices such as S&P BSE Bankex, S&P BSE FMCG Index, Nifty Infrastructure Index and Nifty
Energy Index.
Choice of Investment Universe
Some equity funds investing in different sectors invest in large companies; while there are
others that focus on mid-cap stocks or small cap stocks. S&P BSE Sensex and Nifty 50 indices
2
are calculated based on 30 (in the case of Sensex) / 50 (in the case of Nifty) large companies.
Thus, these indices are appropriate benchmarks for those equity funds that invest in large
companies. For mid cap funds mid cap indices such as Nifty Midcap 50 or S&P BSE Midcap are
considered as better benchmarks.
Choice of Portfolio Concentration
Some equity funds investing in different sectors prefer to have fewer stocks in their portfolio.
For such schemes, appropriate benchmarks are narrow indices such as S&P BSE Sensex and
Nifty 50, which have fewer stocks. Schemes that propose to invest in more number of
companies will prefer broader indices like S&P BSE 100/Nifty 100 (based on 100 stocks), S&P
BSE 200/Nifty 200 (based on 200 stocks) and S&P BSE 500/Nifty 500 (based on 500 stocks).
11.5 Benchmarks for Debt Schemes114
Scheme Category CRISIL Index
Overnight Fund CRISIL Overnight Index
Liquid Fund CRISIL Liquid Fund Index
Ultra-Short-Term Fund CRISIL Ultra Short-Term Debt Index
Money Market Fund CRISIL Money Market Index
Low Duration Fund CRISIL Low Duration Debt Index
Short Duration Fund CRISIL AA Short Term Bond Fund Index
Medium Duration Fund CRISIL Medium Term Debt Index
Medium to Long
Duration Fund CRISIL Medium to Long Term Debt Index
Long Duration Fund CRISIL Long Term Debt Index
Dynamic Bond CRISIL Composite Bond Fund Index
CRISIL Short Term Corporate Bond Index, CRISIL Medium Term
Corporate Bond Fund Corporate Bond Index, CRISIL Long Term Corporate Bond
Index, CRISIL Corporate Bond Composite Index
Credit Risk Fund CRISIL Credit Risk Index
Scheme Type
Liquid schemes invest in securities of up to 91 days’ maturity. Therefore, a short-term money
market benchmark such as NSE’s Liquid or CRISIL Liquid Fund Index is suitable.
Non-liquid schemes can use one of the other indices mentioned above, depending on the
nature of their portfolio.
Choice of Investment Universe
Gilt funds invest only in Government securities. Therefore, indices based on Government
Securities are appropriate. Debt funds that invest in a wide range of Government and Non-
Government securities need to choose benchmarks that are calculated based on a diverse mix
of debt securities.
3
11.6 Benchmarks for Other Schemes
Hybrid Funds
Hybrid funds invest in a mix of debt and equity. Therefore, the benchmark for a hybrid fund
is a blend of an equity and debt index.
For instance, a hybrid scheme with asset allocation of about 65 percent in equity and balance
in debt, can use a synthetic index that is calculated as 65 percent of S&P BSE Sensex and 35
percent of I-Bex. CRISIL has also created some blended indices for hybrid funds (see Table
11.2).
Table 11.2: CRISIL blended indices for hybrid funds
Scheme Category Index Debt Index Equity Index
Aggressive Hybrid Fund CRISIL Hybrid 25+75 – CRISIL Composite Bond S&P BSE 200 (TRI) [75%
Aggressive Index Fund Index allocation]
[25% allocation]
Balanced Hybrid Fund CRISIL Hybrid 50+50 – CRISIL Composite Bond S&P BSE 200 (TRI) [50%
Moderate Index Fund Index allocation]
[50% allocation]
Conservative Hybrid Fund CRISIL Hybrid 75+25 – CRISIL Composite Bond S&P BSE 200 (TRI)
Conservative Index Fund Index [25% allocation]
[75% allocation]
Gold ETF
Gold price would be the benchmark for such funds.
Real Estate Funds
A few real estate services companies have developed real estate indices. These have shorter
histories, and are yet to earn the wider acceptance that the equity indices enjoy.
International Funds
The benchmark would depend on where the scheme proposes to invest. Thus, a scheme
seeking to invest in China might have the Shanghai Composite Index (Chinese index) as the
benchmark. S&P 500 may be appropriate for a scheme that would invest largely in the US
market. A scheme that seeks to invest across a number of countries, can structure a synthetic
index that would be a blend of the indices relevant to the countries where it proposes to
invest.
Standard benchmarks
For the sake of standardization, schemes need to disclose return in INR and by way of CAGR
for the following benchmarks apart from the scheme benchmarks:
Scheme Type Benchmark
Equity scheme Sensex or Nifty
All Debt Schemes having duration / maturity up to 1 1 year T-Bill
year and arbitrage Funds
All Debt Schemes which are not covered in point 2 10 years dated GoI security
4
Conservative Hybrid Fund 10 years dated GoI security
Balanced Hybrid Fund / Aggressive Hybrid Fund Sensex / Nifty
/ Dynamic Asset Allocation or Balanced
Advantage /Multi Asset Allocation
Equity Savings 10 years dated GoI security
Retirement Fund / Children's Fund Sensex / Nifty
Index Funds / ETFs & FoFs (Overseas/ Appropriate benchmark based on the
Domestic) underlying asset allocation as per
above
11.7 Quantitative Measures of Fund Manager Performance
In the section on calculation of returns, the focus was on absolute returns i.e., returns earned
by the scheme. Having understood the concept of benchmarks, one can also do relative
comparison viz. how did a scheme perform vis-à-vis its benchmark or peer group. Such
comparisons are called relative return comparisons.
If a comparison of relative returns indicates that a scheme earned a higher return than the
benchmark, then that would be indicative of outperformance by the fund manager. In the
reverse case, the initial premise would be that the fund manager under-performed. Such
premises of outperformance or under-performance need to be validated through deeper
performance reviews.
Such evaluations are conducted through Risk-adjusted Returns.
There are various measures of risk-adjusted returns. This workbook focuses on three metrics,
which are more commonly used in the market.
11.7.1 Sharpe Ratio
Sharpe ratio is a very commonly used measure of risk-adjusted returns.
An investor can invest with the government and earn a risk-free rate of return (Rf). T-Bill index
is a good measure of this risk-free [Link] investment in a scheme, a risk is taken, and
a return is earned (Rs).
The difference between the two returns, i.e., Rs– Rf is called the risk premium. It is like a
premium that the investor has earned for the risk taken, as compared to the government’s risk-
free return.
This risk premium is to be compared with the risk taken. Sharpe Ratio uses Standard Deviation
as a measure of risk. It is calculated as:
Sharpe Ratio = (Rs minus Rf) ÷ Standard Deviation
Thus, if risk free return is 5 percent, and a scheme with standard deviation of 0.5 percent
5
earned a return of 7 percent, its Sharpe Ratio would be (7 percent - 5 percent) ÷ 0.5 percent
i.e., 4.
Sharpe Ratio is effectively the risk premium generated by assuming per unit of risk. Higher
the Sharpe Ratio, better the scheme is considered to be.
Sharpe Ratio comparisons can be undertaken only for comparable schemes. For example,
Sharpe Ratio of an equity scheme cannot be compared with the Sharpe Ratio of a debt
scheme.
11.7.2 Treynor Ratio
Like Sharpe Ratio, Treynor Ratio too is a risk premium per unit of risk. Computation of risk premium
is the same as was done for the Sharpe Ratio. However, for risk, Treynor Ratio uses Beta.
Treynor Ratio is thus calculated as:
Treynor Ratio = (Rs minus Rf) ÷ Beta
Thus, if risk free return is 5 percent, and a scheme with Beta of 1.2 earned a return of 8
percent, its Treynor Ratio would be (8 percent - 5 percent) ÷ 1.2 i.e., 2.5.
Higher the Treynor Ratio, better the scheme is considered to be. Since the concept of Beta is
more relevant for diversified equity schemes, Treynor Ratio comparisons should ideally be
restricted to such schemes.
11.7.3 Alpha
Non-index schemes too would have a level of return, which is in line with its higher or lower
beta as compared to the market. Let us call this the optimal return.
The difference between a scheme’s actual return and its optimal return is its Alpha—a
measure of the fund manager’s performance. Alpha, therefore, measures the performance of
the investment in comparison to a suitable market index. Positive alpha is indicative of out-
performance by the fund manager; negative alpha might indicate under-performance.
Since the concept of Beta is more relevant for diversified equity schemes, Alpha should ideally
be evaluated only for such schemes.117
11.8 Tracking Error
The Beta of the market, by definition, is 1. An index fund mirrors the index. Therefore, the
index fund, too, would have a Beta of 1, and it ought to earn the same return as the market.
The difference between an index fund’s return and the market return is the tracking error.
Tracking error is a measure of the consistency of the outperformance of the fund manager
relative to the benchmark.
6
11.9 Scheme Performance Disclosure
SEBI has mandated disclosure of performance data by all the asset management companies
(AMCs). These disclosures can be accessed through certain scheme documents and website
of the fund house.
The Scheme Information Document (SID) of each scheme needs to updated once every year,
accordingly, the scheme performance numbers have to be updated as a part of this exercise.
That is where the fund fact sheet plays a vital role which is published on a monthly basis by
all the fund houses. Factsheet is not a statutory requirement.
There are various portals that also could be used to access the scheme performance data.
Many of these portals also carry various other scheme related performance measures. Mutual
funds also make available product literature that can be used by distributors and investors to
evaluate schemes. This information is made available in physical and online mode. The
information and data found in such literature is updated and current, and typically includes
information about suitability, returns and portfolio description. These are explained below.
Fund Factsheets
Apart from information about the schemes themselves, AMCs may also provide periodic
updates on markets and the economy. These are typically part of the factsheets or may be
issued as separate notes. The fund factsheets are an official source of information of the fund’s
objective, performance, portfolio and basic investment requirements issued by the fund
house each month. The factsheet is also used by the fund manager to communicate their
views on the economy and the markets to the investors and other observers such as research
analysts, rating agencies and media.
It is not mandatory for fund houses to publish factsheets. But most fund houses do so as a
way to reach out to the existing and new investors.
Scheme performance available on AMFI website:
AMFI website ([Link]) carries the performance data of all the mutual fund
schemes
