Chapter 11

Mutual Fund Scheme Performance

 Benchmarks

• A credible benchmark should meet the following requirements: It should be in sync with
i. the investment objective of the scheme
ii. asset allocation pattern
iii. Investment strategy of the scheme.
• The benchmark should be calculated by an independent agency. Most benchmarks are
constructed by stock exchanges, credit rating agencies, securities research houses or financial
publications.
• Choice of benchmark is simplest for an index fund.
• The Scheme Information Document has to mention the benchmark.
 Price Return Index or Total Return Index

• 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 gains.
• The gap between the returns between PRI and TRI is the amount of
dividend.
 Basis of choosing an appropriate performance benchmark

• Alignment with the investment objective, asset allocation pattern and

investment strategy of the scheme.
• Benchmarked to the Total Return variant of the Index chosen as a
benchmark
 Benchmarks for equity schemes

1. Scheme type
2. Choice of investment universe
3. Portfolio concentration
 Benchmarks for Debt Schemes

• Scheme Type
• Liquid schemes invest in securities of up to 91 days maturity. Therefore, a
short term money market benchmark such as NSEs MIBOR or CRISIL
Liquid Fund Index is suitable.
• Choice of Investment Universe
• Gilt funds invest only in Government securities .Indices based on
Government Securities are appropriate.
 Benchmarks for Other Schemes
• Hybrid Funds
• Hybrid funds invest in a mix of debt and equity. 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.
• 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.
• International Funds
• The benchmark would depend on where the scheme proposes to invest. Thus, a scheme seeking to invest in China
might have the Hang Seng Index (Chinese index) as the benchmark.
Standard benchmarks
 Example
• If risk free return is 5 percent, and a scheme with standard deviation of
0.5 percent 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.
 Example
• 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.
 Alpha

• The difference between a schemes actual return and its optimal return is
its Alpha. 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.
• These quantitative measures are based on historical performance, which
may or may not be replicated.
 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
funds return and the market return is the tracking error.
• Tracking error is calculated as the standard deviation of the excess returns
generated by the fund. The tracking error has to be low for a consistently
out-performing fund.
 Fund Factsheets

• AMCs may also provide periodic updates on markets and the economy.
• An official source of information of the funds objective, performance, portfolio and
basic investment requirements issued by the fund house each month.
• 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.
• The information disclosed in the factsheets and other product literature is subject to
the advertising guidelines of SEBI.
• The purpose of these updates is to help investors understand the performance of
their schemes.
Thank you