When was the last time you had bought a new cell phone, without checking all the models available in the market? Some even spend days on end — going through the features, accessories and guarantees in various products. Why should buying a mutual fund be any different? After all, it’s your hard earned money.

Next time when your broker or banker advises you to buy a particular product, don’t take his advice blindly. A simple analysis of funds will help you choose a fund that fits your financial needs. One of the most important tools in this process is looking at the benchmarks.

What is a benchmark and what is its use?

A fund’s benchmark is an index that is chosen by a fund company to serve as a standard for its returns. Thus, while comparing, one should only compare funds with similar benchmarks. For example, Reliance Growth, which has BSE 100 as its benchmark, cannot be compared with Reliance Equity that has BSE Sensex as its benchmark. But it can be compared with UTI Mastershare, which also shares the same benchmark.

Besides, the fund is saying that the benchmark’s returns are its target and a fund should be deemed to have done well if it manages to beat the benchmark.

Another philosophy behind the benchmark is that the company gives you a rough indication as to what kind of stocks the fund is likely to invest in. Say, if Franklin India Blue Chip has BSE Sensex as its benchmark, then it should ideally invest in blue-chip (large-cap) companies.

So are benchmarks gold standards in investment?
Of course not. Fund managers often take liberties with their benchmarks. Year 2006 saw large-cap stocks rallying the most. This led to many funds, with mid-cap indices as their benchmark, investing in such blue-chip companies wantonly. Additionally, in the past couple of months, since mid-cap stocks have started rallying again, fund managers are looking at them aggressively, forgetting their funds’ benchmarks for the time being. Have a look at the table. We have compiled a few prominent funds with investments not in line with their benchmarks. While their benchmark is a large-cap index (Sensex or Nifty), they have invested substantially in mid-caps.

So why is this harmful?
Fund managers are not gods. They too are accountable to their employers and more importantly — the investing public. One cannot — and should not — swim against the tide forever. Befriending the trend is one of the ways by which he can deliver good returns for his investors. However, if the composition of the portfolio changes so much that an investor’s investment objective is hurt, then there’s a problem. After all, you put your money in a large-cap fund because you wanted to put a specific part of your portfolio in large-caps (and not mid-caps).

What if benchmarks themselves are wrong?
As the number of schemes in the market increases, fund houses have been coming out with creatively-designed ‘thematic’ schemes to attract investors. For example, if infrastructure stocks are outperforming, you see fund houses launching infrastructure funds (often with Sensex, Nifty or even BSE 100 as their benchmarks). When you compare their returns with the large-cap indices, they often deliver superlative returns. But when you compare them with a more appropriate index like say BSE Capital Goods, they have to bite the dust. Thus, the measurement of performance is sacrificed in a rush to launch schemes.

Last but not the least; keep monitoring your funds’ performance at regular intervals. And if your fund is lagging its benchmark for large period, its time to exit. You don’t use an outdated cell phone for long, do you?