What Is A Benchmark?

A benchmark is an index that the fund’s performance is compared against - the objective of any fund is to exceed the benchmark.

The dictionary defines a benchmark as a “standard or point of reference against which things may be compared”, which is also pretty much what it means in the context of mutual funds. Every mutual fund needs to have a benchmark that the performance of the fund can be compared against. This lets the investors determine how well the fund is performing and thus take informed decisions about their investments.

How is a benchmark determined? Let us take an example to illustrate. Let us say there is a fund that is focused on investing in the automotive industry. The benchmark for the fund would be an index that comprises the leading auto companies. The index measures the performance of the top companies in the industry and the performance of the fund would be compared with the index. If the fund does better than the index, then it has performed well. The benchmarks are independent and are based on the objectives of each fund. For example, most of the large-cap oriented equity funds benchmark themselves against the Sensex or the Nifty; most of the small-cap oriented equity funds benchmark themselves against the S&P BSE Small-Cap or the Nifty Smallcap 250.

If the fund is also investing in the same companies as measured by the index, why would the benchmark and the fund perform differently? The weightage given to certain companies in the fund and in the index can be different. That?s what makes a fund manager good at his job! - The ability to 'read' the companies and accurately determine how well they would be performing in a given period of time.