What is the new dual benchmarking system of mutual fund schemes, how it impacts investors

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Sebi recently introduced a dual structure for benchmarking of mutual fund schemes. From 1 January 2022, open-ended mutual funds from some categories will sport two benchmarks—a standardised index and a bespoke index. Does this new system make life simpler for investors?

A few years ago, the regulator introduced standardisation in investible stocks or bonds for each fund category. This was aimed at tempering the unbridled flexibility in security selection practised by funds within a category, and making fund portfolios more aligned with their chosen mandates. It ensured that the funds you invest in largely conform to the mandate and your own risk tolerance. But AMCs are still allowed to select the most appropriate benchmark for each scheme. Benchmarks play a critical role in gauging an actively managed fund’s performance. These help the investor in assessing if the fund’s return compares favourably with a relevant market standard. But in the absence of a fixed standard or gauge, funds within same category continue to benchmark performance to varying indices. This makes for uneven performance comparison.

Multiple benchmarks for same category make for uneven comparison

A CRISIL analysis of major equity and debt-oriented schemes shows that dispersion in terms of benchmarking by funds within a category remains high. For instance, within large-cap funds, there are six unique benchmarks being used by the underlying schemes. Similarly, ELSS funds and gilt funds have seven unique benchmarks in use. Corporate bond funds have as many as eight unique benchmarks.

Sebi aims to address this by bringing in more uniformity in the benchmarking system. Under the dual benchmark structure, open-ended mutual funds in both equity and debt categories will now have to adopt a primary benchmark in the form of a standardised index that reflects the broader fund category or mandate. So all flexi cap funds may now be benchmarked to a standard index such as the NSE Nifty500 or S&P BSE500. The relevant index will be collectively chosen by AMCs and communicated to the regulator through AMFI. This will bring in uniformity in terms of performance comparison for schemes within a single mutual-fund category.

Additionally, funds will be allowed to adopt a second ‘bespoke’ benchmark that reflects the investment style or strategy of the scheme. This benchmark will be optional and left to the discretion of the AMC. Its utility will purportedly extend beyond the primary index to enable investors to identify the specific strategy and style of the underlying scheme. For instance, a large-cap oriented flexi cap fund may choose the Nifty200 index fund as its second benchmark to better reflect the risk-return profile of its target universe. At a microscopic level, it may facilitate identification of schemes following a particular strategy within the broader category, apart from a better comparison of schemes running a similar strategy within a category.

However, experts feel the discretion to introduce a second benchmark may undo the benefit of having a single standardised index, and create unnecessary confusion. Gaurav Rastogi, CEO, Kuvera, reckons it adds complexity to benchmarking that doesn’t help anyone. “If selection of the second benchmark is left to the AMC, it may be used ambiguously by some AMCs. Some may resort to playing up either of the two benchmarks interchangeably, as per market circumstances,” he says. Vidya Bala, Head-Research, PrimeInvestor.in, contends that this option leaves open ground for AMCs to introduce custom-built indices to showcase relative performance. It is also possible that two funds following same style or strategy may adopt different index for use as ‘bespoke’ benchmark.

Most experts say investors don’t need to look beyond the mainstream broader indices. The primary benchmark—reflecting category mandate—on its own should be enough to aid in performance assessment. Bala exhorts investors not to get distracted by newer bespoke indices. “As an investor, all you expect is that your fund beats the market over time. Broader market indices are enough to facilitate this comparison,” she says. If at all, the second benchmark may only be referred to for deeper analysis of style deviation. Debt funds can do without any benchmark comparison. Given the similarity of debt funds within the same category, these are more suited for peer-to-peer comparison, Bala insists.

Not all funds will feature two-tiered benchmarks though. There would be a single benchmark for thematic and sectoral funds as well as index funds and ETFs. Hybrid and solution-oriented schemes would also feature a single benchmark based on a broad market benchmark wherever available. Else, a bespoke benchmark will be created, which would then be applicable across funds in the category. In case of Fund of Funds (FOFs), the benchmark of the underlying scheme will be used for schemes investing in a single fund whereas a broader market index will be used for the FOF investing in multiple schemes.

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