How important is the benchmark?

amp;149;Between the Nifty and the Sensex,why is the Nifty more popular?

While the Nifty is a 50-scrip index,the Sensex is a 30-scrip index. Both these indexes consist of large-cap scrips. The Nifty is more representative of the market as it represents nearly 85-90 per cent of market capitalisation. The Sensex,on the other hand,represents only 75-80 per cent of total market capitalisation.

Part of the reason why so many funds are benchmarked against the Nifty and the Sensex is historical. Says Prasunjit Mukherjee,a Kolkata-based mutual fund analyst: Most of the older funds have the Nifty or the Sensex as their benchmark because no other indexes were available when these funds were launched. Of the two,the Nifty has a wider base than the Sensex and is easier to track because of its conveniently larger basket of stocks that are liquid. The Sensex,on the other hand,is a more concentrated index comprising just 30 scrips. Its movements,therefore,are very sharp. There are larger upsides and downsides to this index.

amp;149;How did the various indexes perform in 2008?

The financial crisis took a toll on all the stock market indexes. In 2008,BSE 200 fell 57 per cent; BSE 100 shed 56 per cent; Sensex plummeted 53 per cent; and Nifty was down 52 per cent.

amp;149;Normally you would expect a more diversified index to be less volatile. Then why did indexes like the BSE 100 and BSE 200 decline more?

Explains Mukherjee: BSE 100 has a number of mid-cap stocks and BSE 200 has an even larger number of these stocks. During the downturn,mid-caps have lost more value than large-caps. It is the mid-cap component that has caused these indexes to decline more. The BSE mid-cap index fell around 67 per cent last year.

amp;149;Are there any pros and cons to different benchmarks?

Not really. Says Mukherjee: Choosing between benchmarks is a matter of allocating funds to different baskets of stocks.

All indexes come with their own benefits and drawbacks. If the benchmark is small and concentrated,such as the Sensex,its movement will depend on a few stocks. For instance,on the day the fraud at Satyam came to light and the stock took a major hammering,it pulled the Sensex down by 750 points within a single trading day. On other days,there could be similar sharp upward movements. Funds tracking such an index would have to take concentrated bets on stocks to be able to beat the index.

Benchmarks such as the CNX 500,on the other hand,are extremely diversified and are difficult to track as many of the mid- and small-cap stocks in these indexes are illiquid and are not easily available.

Options such as Nifty 50,BSE 100 and BSE 200 are easier to track because they are not very concentrated and the stocks therein are also more liquid.

amp;149;In recent times,many funds such as Principal Resurgent India Equity Fund,Principal Growth Fund,and Principal Large Cap Fund changed their indexes. What is the significance of this move?

If a fund revises its benchmark,it is a welcome move and should be seen as a proactive step on the part of its fund manager. Says Mukherjee: It indicates that the fund manager wants to take advantage of a larger universe of stocks and broad-base his investment category.

amp;149;Should the benchmark be a criterion in your selection of funds?

Yes,says Pune-based financial planner Veer Sardesai. First look at your own risk profile and then choose a fund with a suitable benchmark, he says. An index such as the Nifty,he explains,has lower volatility than the BSE 200. Only if you have higher risk appetite should you choose a fund benchmarked against the BSE 200. The BSE 200 has a mid-cap and a small-cap component as well that makes it more volatile. The funds benchmarked against BSE 200 could be expected to be more volatile than funds benchmarked against the Nifty. Further,he says,if you prefer to invest in an index fund,then too the choice of benchmark becomes important,and it should be made according to your risk appetite.

Mukherjee,on the other hand,doesnt think that the benchmark is all that critical. Organisations use the benchmark to indicate whether the fund is diversified or focused.

But remember that 50 per cent of the funds actions take place outside the benchmark.

While keeping Sardesais point in mind,the investors choice of mutual fund should,in addition to the benchmark,also depend on factors such as past performance,the fund managers track record,and so on. The benchmark comes in at the time of evaluating performance. Not only should the fund have consistently beaten its benchmark,it should also have performed well vis-à-vis its peer group. u

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