Weird benchmarks provide skewed perspective of fund performance
April 30, 2010
Mutual fund companies do not attempt to make fixed high returns on their schemes. You cannot judge a fund’s performance based on the absolute returns it generates. Funds always measure their performance against an external standard called the ‘benchmark index’. Fund mangers hope to beat the benchmark they have chosen to compare themselves against.
But is this comparison truly indicative of the fund manager’s performance in active stock selection? Not if the benchmark chosen is itself a skewed and obscure index that does not in any way reflect the fund scheme’s investment objective. A recent S&P-CRISIL study found that as many as 56% of the equity funds currently active are benchmarked to inappropriate indices. It is a classic case of comparing apples to oranges.
This aspect makes a mockery of the very idea of having benchmarks to compare against. Most often, fund companies get so carried away with the way they create schemes that they end up selecting weird benchmarks. The most ridiculous part of this is that, retail investors cannot track the performance of many of these benchmarks. So how is an investor supposed to analyse the performance of the fund?
A previous Moneylife study found that 13 sector funds are benchmarked to indices, which are strange constructs. Worse, data on the performance of these benchmarks are not available for public consumption. Funds use indices like the CNX Service Sector, S&P CNX Pharmaceuticals, CNX MNC Index and S&P CNX Media and Entertainment Index, which are paid indices. Only subscribers to these services can avail of the data for these indices.
There are several other instances of benchmarks not matching the fund’s investment objective. A mid-cap oriented fund may be benchmarked against the broader Nifty index or a small-cap fund to the BSE 500. Very often, fund performance is measured against popular benchmarks like the S&P CNX Nifty or the BSE Sensex without consideration of the size of the fund scheme or its investment style.
While fund companies in India are known to launch fancy schemes, these are also accompanied by even more lopsided and innovative benchmarks. UTI Growth Sector Fund, for instance, is so innovative that it actually uses two benchmarks that are both obscure—CNX Service Sector and S&P CNX Pharmaceuticals.
Investors in such funds should not go by the performance comparison offered by such twisted benchmarks. They should try and compare the fund performance with an index that is more relevant and suited to the fund’s investment strategy.