Investor Corner/Building and judging a portfolio/Evaluating Funds
3.3.5 Benchmark Selection
A fund should be judged against an appropriate benchmark, matched to its own market cap segment and investment style. Comparing a mid cap fund's returns to the Nifty 50, a large cap index, is a common and genuinely misleading mistake.
Why the comparison has to be like-for-like
Mid cap and small cap stocks have historically behaved quite differently from large cap stocks, particularly in terms of volatility and the typical timing of their outperformance and underperformance relative to each other. Comparing a mid cap fund's return against a large cap index during a period when large caps happen to be leading makes the mid cap fund look artificially worse than it actually is relative to its true, appropriate peer group.
The benchmark is the index against which a fund's performance is measured. Choosing the right benchmark is critical because it determines whether the fund's returns look good, average or poor. A mid-cap fund benchmarked against the Nifty 50 may look like it is outperforming during a small-cap rally, but compared to the Nifty Midcap 150 (a more appropriate benchmark) it might be lagging. The benchmark must match the fund's investment universe and style for the comparison to be meaningful.
Getting the comparison right
A mid cap fund should generally be measured against a mid cap index. A value oriented fund should ideally be measured against a value tilted benchmark where one reasonably exists, rather than a broad, style agnostic index. Regulation generally requires funds to disclose their designated benchmark clearly, and that stated benchmark, not an unrelated one, is the fair basis for judging that specific fund's performance.
SEBI mandates that each mutual fund declare a benchmark at launch, and the benchmark should correspond to the fund's category. Large-cap funds typically benchmark against Nifty 50 or BSE 100. Mid-cap funds against Nifty Midcap 150. Flexi-cap funds against Nifty 500 or BSE 500. Debt funds benchmark against relevant CRISIL or NIFTY debt indices. The fund cannot change its benchmark to flattering comparisons; it must use the declared benchmark in all performance reporting.
Always check that the benchmark comparison in the factsheet uses the Total Returns Index (TRI), which includes dividends reinvested, not the price index. The TRI is typically 1-1.5% higher per year than the price index. A fund that reports outperformance against the price index but underperformance against the TRI is not actually beating the market; it is benefiting from an unfair comparison. SEBI now mandates TRI-based benchmarking, but older performance data in some reports may still use the price index.
Why this matters for realistic expectations
Setting the wrong benchmark expectation can lead to either unfairly harsh judgment of a genuinely well-performing fund, or unwarranted confidence in a fund that is simply riding a broader tailwind common to its entire category or segment rather than demonstrating genuine, fund-specific skill.
How PriLytics helps. PriLytics lets you compare any holding against a chosen benchmark such as the Nifty 50 TRI, over any period, so comparisons are made on your own terms with full transparency. Compare against a benchmark.
When evaluating funds across different categories, resist the urge to compare raw returns. A small-cap fund returning 18% has not outperformed a large-cap fund returning 14% in any risk-adjusted sense if the small-cap benchmark returned 20% while the large-cap benchmark returned 12%. The correct comparison is each fund against its own benchmark. The large-cap fund outperformed its benchmark by 2 percentage points; the small-cap fund underperformed by 2 percentage points. The appropriate benchmark transforms raw return numbers into actionable performance information.