12.1 Benchmarks and Performance

What a Benchmark Is For

A benchmark is the index representing the passive alternative available to an investor in the same segment of the market. It answers the only question that makes a return figure meaningful:

Did the investor do better by paying for this scheme than by simply owning the market it invests in?

A scheme that returned 19% has performed well against a benchmark that returned 14% and poorly against one that returned 26%. The absolute number alone carries almost no information, which is why SEBI requires benchmark returns to be presented alongside scheme returns for identical periods.

The Two-Tier Benchmark Structure

SEBI introduced a two-tier framework with effect from December 2021.

Tier 1 is prescribed at category level, and AMFI publishes the list, so every scheme in a category is measured against the same broad index. This is what makes cross-AMC comparison possible: two large cap schemes from different fund houses are judged against the same yardstick rather than against benchmarks each chose for itself.

Tier 2 exists because a broad category index cannot capture every legitimate strategy. A large cap scheme run with a pronounced quality tilt may adopt a quality index at Tier 2, so its investors can see performance against both the broad market and the specific approach the manager follows.

For sectoral and thematic schemes, the Tier 1 benchmark reflects the sector or theme, and the two-tier structure applies in the manner SEBI prescribes for those categories.

For index funds and ETFs, the benchmark is simply the index being tracked, and the relevant measure of success is not outperformance but tracking error, covered in section 12.7.

Why a Prescribed Benchmark Matters

Before benchmarks were standardised at category level, an AMC could select an index against which its scheme happened to look strong. A large cap scheme benchmarked against a broad-market index including mid caps would appear to outperform in a period when large caps led, purely from the composition mismatch.

Prescribing Tier 1 at category level removed that discretion. The benchmark now describes the category, not the scheme's preference.

Reading Performance Against a Benchmark

Two cautions apply throughout.

Compare over a full cycle. A value-oriented manager lags during a growth-led rally by construction, not by error. Three years is a minimum for a meaningful judgement, and five is better.

Compare net of expenses. Scheme returns are computed from NAV and are therefore already net of the expense ratio. The benchmark carries no expenses at all. A scheme matching its benchmark has in fact earned back its entire expense ratio through active management — a better outcome than the raw comparison suggests.

Benchmark Comparison Is Mandatory Disclosure

• Benchmark returns must appear alongside scheme returns for the same prescribed periods
• Benchmark returns must be computed on a Total Return Index basis
• The benchmark and the reason for its selection are disclosed in the Scheme Information Document
• A change of benchmark must be disclosed and explained

A change of benchmark deserves particular attention when reviewing a scheme. There are legitimate reasons — a category redefinition, a better-constructed index becoming available. There is also an illegitimate one, which is switching to an index the scheme has been beating. The disclosure requirement makes the change visible; reading it is the analyst's job.

What a Distributor Should Do

• Never quote a scheme return without its benchmark return for the same period
• Use the Tier 1 benchmark, since it is the standardised category yardstick
• Where the fact sheet shows a Tier 2 benchmark, read both — the gap between them describes the manager's style
• Check whether the benchmark has changed, and why
• Explain to investors that a scheme merely matching its benchmark has covered its costs through active management