I have been told that the performance of equity funds should be gauged against their benchmark. What are these benchmarks and how do you suggest that I use them?
Sunita Ray, via e-mail
There are many ways to check the performance of an equity fund. One way is to compare it with other similar funds.
Another more fundamental approach is to check the performance of the fund against its benchmark. A benchmark is a frame of reference, a context and a standard that allows us to check a fund's performance. In the case of equity funds, this benchmark is usually an index such as the BSE Sensex or the Nifty. These indices are a collection of stocks, which together are meant to represent the equity market.
The fund manager's responsibility is to manage his portfolio in such a manner that over time, he or she is able to generate returns that are superior than that of the benchmark indices. At the core of the fund management business is the idea of beating the market indices. Thus, each fund chooses a particular benchmark index and tries to outperform it.
So, while checking the performance of your actively managed fund, do check how it performs against its benchmark. While a return of 20 per cent may appear decent, always see how the benchmark index has done to get a fair idea.
Another use of a benchmark is to see how a fund's portfolio is spread out in comparison to the benchmark. A fund manager tries to beat the market index by being overweight in some sectors and underweight in other sectors. What this basically means is that if the fund is bullish on banking, the fund manager will allocate a greater proportion of his funds to banking stocks as compared to the index.
Similarly, if the fund manager is less confident about IT, then the allocation to this sector will be less vis-a-vis the benchmark. Thus, by comparing a fund's sectoral allocation to that of the benchmark one can get a bird's eye view of what sectors the fund manager is bullish or bearish about. This also allows you to check your comfort level in terms of your personal sector preferences. A look at the table (Sector Vector) will give you an idea about how some equity funds, which benchmark against the Sensex view different sectors.