12.4 Benchmarks for Equity Schemes

The Capitalisation Foundation

Equity benchmarking rests on AMFI's half-yearly classification list, which every AMC must use:

The list is revised half-yearly on the basis of average market capitalisation over the preceding six months, and schemes are given a defined window to realign portfolios after each revision. Because every fund house uses the same list, a company is large cap for the whole industry simultaneously.

Benchmarks by Equity Category

Note that the 80% minimum equity for dividend yield, value, contra, focused and ELSS schemes reflects SEBI's revised categorisation, which raised the threshold from 65% so that these categories stay true to their labels.

Why Sectoral and Thematic Schemes Need Their Own Index

A banking sector scheme compared against a broad market index tells you almost nothing about the manager. In a year when banking outperforms, every banking scheme beats the broad market; in a year when it lags, every one of them trails.

Benchmarking against a banking sector index separates the two questions:

• Did the sector do well? — visible from the sector index against the broad market
• Did the manager do well within the sector? — visible from the scheme against the sector index

Both matter, and only the second is about the manager. An investor in a sector fund has made the sector call themselves; what they are paying the manager for is stock selection inside it.

Tier 2 Benchmarks in Equity

Where an AMC adopts a Tier 2 benchmark, it reflects the specific style within the category — a quality index, a value index, a low-volatility index. Reading both benchmarks together is informative:

The second row matters most in practice, because it identifies a manager worth retaining through a period when the raw numbers look poor.

Total Return Basis

Every equity benchmark comparison uses the Total Return Index version. The suffix TRI in the table above is not decoration — comparing against the price version overstates the scheme's performance by roughly the market's dividend yield, as section 12.2 established.

Practical Guidance for Comparison

1. Identify the scheme's category, not its name.
2. Use the prescribed Tier 1 benchmark for that category.
3. Compare on a TRI basis over the same periods.
4. Compare against category peers as well as the benchmark, since category and benchmark can diverge.
5. Assess over a full market cycle, and prefer rolling returns where available.
6. Check whether the scheme's actual market-capitalisation split matches its category — a flexi cap fund running mostly large caps should be understood accordingly.

A Worked Comparison

An investor is shown two small cap schemes over the same three-year period.

Read on the headline number, Scheme Q wins by three percentage points a year. Read properly:

Scheme P : 21.0% - 18.0% =  +3.0 points versus benchmark
           21.0% - 20.0% =  +1.0 point  versus category
Scheme Q : 24.0% - 26.0% =  -2.0 points versus benchmark
           24.0% - 25.5% =  -1.5 points versus category

Scheme P added value against both its benchmark and its peers; Scheme Q trailed both. The gap in raw returns came from the periods being different market environments for the two funds' benchmarks, not from the managers. Comparing two schemes against each other without anchoring each to its own benchmark and category is the single most common analytical error a distributor makes.

Benchmark Against Category, Not Only Against Index

Both comparisons are needed, and they answer different questions.

• Against the benchmark: did active management beat the passive alternative, net of the expense ratio?
• Against the category average: did this manager do better than others working under the same constraints in the same conditions?

A scheme can lag its benchmark and still be the best available option in its category — index funds aside — and a scheme can beat its benchmark while sitting in the bottom quartile of peers. Neither comparison alone tells the investor what to do.

Practical Note on Thematic Schemes

For sectoral and thematic schemes, remember that the investor made the sector call. Judging the manager against a broad market index credits or blames them for a decision the investor made, which is why the sector index is the only fair reference.