Mutual Fund Returns: Reaching Your Money Goals Is More Important, Not Beating Benchmarks

Equity mutual funds have been extremely popular among those who do not understand the nitty-gritty of stocks

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Every investment, whether it is stocks, mutual funds, real estate or gold, has one common objective: to generate inflation-beating returns. Likewise, every investment has a certain benchmark that sets the risk boundary and minimum return criteria. But this tends to become a double-edged sword that can distort the broader picture.


Equity mutual funds have been extremely popular among those who do not understand the nitty-gritty of stocks. Not only they are managed by professional management, but also they have managed to deliver decent returns year after year.

Many investors, while selecting the fund, use benchmarks to gauge the performance of the fund. Investing is not about beating the benchmark; it is about achieving financial goals. There are many schemes that have underperformed the benchmark, yet managed to clock annualized returns of 13-14 per cent. Thus, even if the fund is underperforming in the initial years, it still can deliver decent returns that are enough to achieve one's financial goals.

Let's look it at another way when markets become volatile, and it falls 10 per cent. The fund you have invested falls by 9 per cent, you have still beaten the benchmark by generating positive alpha. While benchmark helps you to gauge whether your investments are doing better or worse than the broader market, it should not be used to evaluate funds.

Growth equity funds invest in companies that have the potential to become multi-baggers. These funds invest in companies that are young but has the potential to grow at above-average rates than industry. This is a high-risk strategy that is in complete contrast to value investing. It is possible that these funds might underperform initially. For example, a particular small cap fund underperformed NIFTY Small Cap 100 in 2017 by a huge margin. The small cap fund delivered only 9.85 per cent return while NIFTY Small-Cap index delivered a phenomenal 50.45 per cent return. But in three years, i.e. by 2021, the fund managed to deliver 169 per cent absolute return while NIFTY Small-Cap index delivered 72 per cent return.

Is Benchmark Performance Analysis Necessary?

No. The above example shows that investing merely to beat the benchmark year-on-year basis might not prove to be the best idea. One should compare the fund's performance with the benchmark only if the fund has consistently underperformed for 2-3 years. Comparing the fund with the benchmark on a year-on-year basis will distort the bigger picture and might lead to erroneous decisions.

A benchmark is just the gauge of risk boundaries that exist in a particular category. It sets a minimum standard of performance. But an actively managed fund with good management will always outperform the benchmark in the long run. Some funds have consistently outperformed the benchmark even during the recessionary phase. You would have missed the opportunity to invest in them if you would have followed the benchmark returns strategy.

Investing helps you to chase and successfully achieve your financial goals. If you are looking for higher returns then you must invest in the fund that gives the highest return in its category. Actively managed funds follow different strategies and risk profiling than passively managed funds. While investing in a fund, you should keep your goal in mind, and the returns required to achieve the goal. The returns based approach helps you to allocate your assets efficiently.

Goal-based investing helps you to focus on returns instead of chasing benchmarks. If your goal is 10 years away, it makes sense to invest in an equity fund. This will help you to generate inflation-beating returns and also achieve your goal with ease. If your goal is 2-3 years away, you should invest in fixed income funds. The right mix of asset allocation is key to success in investing. While investing in actively managed funds always make sure your investment style aligns with the fund manager. If you believe in value-investing then there is little point in investing in a fund that follows the strategy of growth investing.

The benchmark should be used only as a guiding factor, and should not be the sole determinant of investing. Structuring your portfolio around the benchmark will always give you average returns that reflect the performance of the benchmark. If you want to achieve your goals, both short as well as long term, you should structure your portfolio with actively managed funds.

Not all funds are equal. The same principle applies to investing strategies. The strategy of benchmark only evaluation can lead to confusion and wrong decisions that can hamper the growth of your portfolio. If you do not have the expertise of evaluating fund portfolio and fund strategy, you must consult a qualified financial advisor who would help you to design the right portfolio mix to maximize returns.