If your fund has beaten tier-II benchmark, just don't exit: Analysts

Stick to it, even if it lags its tier-I benchmark and category average

Until now, investors have compared their mutual fund scheme’s performance against a single benchmark. The more diligent among them would have also compared their fund’s performance against the category average. In future, however, many funds could sport two benchmarks — a tier-I (primary) and a tier-II (secondary) benchmark.

Through a circular dated October 27, 2021, the Securities and Exchange Board of India (Sebi) had mandated a two-tier benchmarking structure for certain categories of schemes. The Association of Mutual Funds in India (Amfi) had to publish a list of tier-I benchmarks, which were to be adopted by funds from January 1, 2022. On December 10, 2021, Sebi extended the implementation date to April 1, 2022.

Tier-I benchmark

Earlier, different funds within the same category had different benchmarks. In the large-cap category, for instance, funds benchmarked themselves against the Nifty50, Nifty 100, S&P BSE 100, and so on.

In future, funds will have to benchmark themselves against one Amfi-prescribed benchmark. “Benchmarks provided by multiple agencies exist. Each asset management company can select one of them,” says Piyush Gupta, director-funds research, CRISIL. NSE, S&P BSE, and CRISIL are the three benchmark providers.

Amfi has published the list of tier-I benchmarks. Large-cap funds, in future, will have to benchmark themselves against either the Nifty 100 or the S&P BSE 100. “This will bring standardisation in the benchmarks used by funds. It will result in investors making an apple-to-apple comparison when comparing a fund’s performance with a benchmark,” says Gupta.

A tier-I benchmark will reflect its category’s broad performance.

Benchmarks are also used in the calculation of several ratios. “Information ratio, for instance, uses benchmark return. In future, the standard benchmark can be used in all such calculations,” says Kaustubh Belapurkar, director-manager research, Morningstar Investment Adviser India.

Tier-II benchmark

Within a category, however, funds follow a variety of strategies. “The tier-II benchmark is meant to take into cognisance the positioning of the fund — its investment style,” says Lakshmi Iyer, chief investment officer-debt and head-products, Kotak Mahindra Asset Management Company.  

In the case of a debt fund, funds belonging to the same duration category sometimes follow very different credit strategies. Sandeep Bagla, chief executive officer, Trust Mutual Fund, says: “Our short-duration fund invests only in ‘AAA’ bonds. It doesn’t participate in the non-‘AAA’ segment of the market. The category benchmark would include both ‘AAA’ and non-‘AAA’ bonds, and hence is not a suitable benchmark for our fund.” Fund houses that feel the need to have a customised benchmark can get one prepared by an index provider. “We asked CRISIL to make a customised benchmark for our short-duration fund, which we have been using for the past three months,” adds Bagla.

Equity funds could also require a tier-II benchmark. Within the flexi-cap category, for instance, you could have funds that follow a value, quality, growth or momentum strategy. Comparing the performance of all these funds using a common benchmark would amount to comparing chalk to cheese.

What you should do

With two benchmarks, an investor can carry out a more nuanced evaluation of her fund’s performance. During a bull run, a value-oriented large-cap fund could lag both the tier-I benchmark and the category average (since the majority of funds in the category are likely to be growth oriented). “In such a situation, the investor can compare his/her fund’s performance with the tier-II benchmark. If it is doing reasonably well vis-à-vis its customised benchmark, he/she can avoid the knee-jerk response of exiting the fund,” says Kumar.

According to Iyer, the intent of such heightened granularity in disclosures is to give investors a feel of what to expect when they enter a scheme. “Studying the benchmarks will prevent investors from entering into the wrong schemes,” she says.