Mutual Fund Benchmark — The Number Behind the Number

A mutual fund benchmark is a stated index that represents the part of the market a scheme invests in. Every scheme names its own, and that name sits in the scheme documents and on the monthly fact sheet rather than being something you have to guess.

The point of it is to separate two things that get mixed up constantly: how the market segment did, and what the scheme did within it. A scheme that rose while its segment rose more has not done well, and a scheme that fell less than its segment during a bad year may have done its job.

Our page on the scheme fact sheet covers where this appears in the monthly document and what else sits alongside it.

Most misleading comparisons are not lies. They are mismatches, and they happen in both directions.

A scheme holding mid-sized and smaller companies compared against a broad large company index will look impressive in a stretch that favoured smaller companies and dreadful in the reverse, and neither result says much about the manager. A concentrated sector scheme compared against a diversified index is not being measured at all. Our pages on large, mid and small cap funds and sectoral and thematic funds set out how different those segments behave.

The fix is simple and almost nobody does it: check what the scheme itself names as its benchmark and use that, rather than whichever index the comparison you are reading happened to choose.

An index can be quoted in a price version, which tracks only the movement in prices, or a total return version, which also counts the income the constituent companies distribute.

Since a scheme actually receives that income and it forms part of what you get, comparing a scheme against a price-only index flatters the scheme. It is measuring something that collects income against something that does not.

Total return versions are now the standard reference for this reason. It is a detail that sounds technical and it is one of the few places where a comparison can be quietly tilted without anybody saying anything untrue.

Two words appear constantly in this context, and both are useful only within limits.

Alpha describes the part of a result not explained by the benchmark, in either direction. Beta describes how much the scheme tends to move relative to the benchmark, so a value above one indicates it has moved more, both up and down. Both are calculated over a chosen period, which means both change when the period changes.

There is also a limit to how much either can tell you about a debt scheme, where the meaningful comparison is less about beating an index and more about whether the scheme took on more credit or duration risk than its category implies. A better outcome achieved by holding lower-quality paper is not the same as a better outcome, and the benchmark alone will not tell you which happened. Our page on debt funds sets out the two risks involved.

They are descriptions of what has already happened. Treating them as properties of the scheme rather than as measurements of a stretch of time is the mistake, and it is the same mistake our page on how to choose a mutual fund warns about with past returns generally.

One year against a benchmark is close to noise. A style that is out of favour can lag for a long stretch and then lead, and judging on a short window means switching out at exactly the wrong point.

What is worth looking at is consistency across several years, including at least one bad one, and whether the scheme behaved the way its stated mandate says it should. A scheme that describes itself one way and holds something else is telling you something more useful than any single year of numbers.

Our guide on why somebody else has a better number deals with the version of this that happens in conversation rather than on paper.

The comparison people actually want to make is between two schemes, and this is where the benchmark does its quietest work.

If both schemes name the same benchmark, comparing them directly is reasonable, because they are attempting the same task. If they name different ones, the comparison is between two different jobs and the numbers are not really speaking to each other, however neatly they sit side by side in a table.

This is the single most common error in the comparisons that circulate on messaging groups. Two figures, no reference, and no indication that one scheme was investing in a completely different part of the market from the other.

A scheme can also change its stated benchmark, which happens after a category redefinition or a change in mandate. When it does, the older performance history was measured against something else, and reading straight across that break is misleading.

An index fund does not try to beat its benchmark. It tries to match it, so the only meaningful measure is how far it drifted from the index and what it charged to do so, as our page on index funds explains.

That is worth knowing even if you never hold one, because it clarifies what you are paying for elsewhere. A scheme with a manager making choices is charging for the attempt to do better than the benchmark, which our page on the expense ratio quantifies.

Whether that attempt has worked is exactly the question a benchmark comparison answers, over a long enough period. We do not recommend schemes here, and we are distributors rather than investment advisers, but if you want help reading what you already hold against the right reference, get in touch.