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Exploring Mutual Funds – Benchmarks

Ray Calleja

An article written by Ray Calleja: Head – Private Clients, MeDirect


In this article we will discuss what is a benchmark and also understand the usefulness of a benchmark. Before buying any mutual fund one of the questions that needs to be asked is how has the fund performed.

The benchmark is a tool that provides indicative return against your mutual fund. The significance of a benchmark index is to provide a perspective and relevant yardstick to measure mutual fund returns. This enables investors to gauge a fund manager’s investment capabilities, as every fund manager aims to outperform the fund’s benchmark index over the long term.

Fund’s returns have to be put into context. Viewing a fund’s returns in isolation is completely misleading. Every mutual fund has to specify a benchmark index against which the fund’s performance can be viewed. A fund that produced returns of 20% for the past five years many would say has done better than a fund which returned 15% over the same period. However, that may not always be the case. The fund that gained 15% may have beaten competing funds that follow the same investment style by five percentage points, while the one which gained 20% may have considerably lagged its own competitors. That is why you need to compare the fund’s returns to appropriate benchmarks – to indices and to other funds that invest in the same type of securities.

Fund houses select benchmark indices on the basis of market capitalisation and sectoral or thematic strategies of the respective funds. For example, in the US, large-cap funds (which invest in companies with a market capitalization of $10 billion or more – the market cap is the company’s number of shares times the stock price) would have large cap indices, such as the S&P 500, which is widely regarded as the best single gauge of large-cap U.S. equities. The index includes 500 leading companies and captures approximately 80% coverage of available market capitalization. The Dow Jones Industrial Average (DJIA) may be the index that heads the stock market report but it is rarely used as a performance benchmark for stock mutual funds. This is because it includes just 30 large-company stocks, so it is not indicative of the health of the overall stock market. Similarly, for mid-cap funds (which invest in companies with market capitalizations between $1 billion and $5 billion) the most widely referenced index is the S&P Mid-Cap 400 but obviously there are others, such as the Russell Midcap and Wilshire US Mid-Cap Index. For small-cap funds (investing in companies that fall into the small-cap category, which have market caps between $300 million and $2 billion) there is the Dow Jones U.S. Small-Cap Total Stock Market Index or the Russell 2000 (created by the Frank Russell Company and is comprised of around 2,000 small-cap companies), which are the most popular. The Barclays Aggregate Bond Index is a good gauge for most taxable-bond funds. There are dozens of other indices that segment the market even more, focusing on regions of the world or even particular areas of the bond market such as maturity or credit rating to capture a narrower slice of the market.

The second type of benchmark that is used is peer groups, or funds that buy the same types of securities as your fund. If  you are buying a fund that invests in large, undervalued companies you have to compare it with others with the same style, i.e. in large-value funds. That way, you’re comparing apples to apples.

Our partner, Morningstar, classify mutual fund into categories which are suitable peer-group benchmarks for most mutual funds. Depending on what a fund owns, it can land in one of more than 40 Morningstar categories. For example, if a fund’s portfolio features large-company stocks with high earnings growth, the fund is categorized as a large-growth fund. The MeDirect website provides Morningstar reports for each mutual fund available on its platform and the category is shown at the top of such reports.

A fund manager can gauge the performance of his fund against other funds with a similar investment objective. He will compare his own fund against the average performer in the sector in the same category, where the fund is grouped. In this way he can measure how well or how bad his fund has been doing when compared to funds in the same peer category. However, he can only find out what his competitors have done since obviously he is not in position to know before-hand what they are planning to do in the future.

Typically, large-cap companies have lower downside risk, funds with large-cap indices as their benchmark would suit investors with low risk appetite. Similarly, funds with mid or small-cap indices will suit those having a higher risk appetite. Benchmark indices also help give investors a fair idea about the portfolio composition of the fund and thereby help them make their investment decisions after considering their risk appetite and return expectations.

If a mutual fund delivers significantly higher returns than its benchmark index or falls lesser than its benchmark index during a market downturn, then it is considered to have outperformed its benchmark index. Similarly, a mutual fund consistently outperforming its benchmark index over several periods indicate consistency in its performance. However, an actively managed fund generating a similar return as of its benchmark index is considered as an under-performance as the fund has failed to meet its basic objective of beating its benchmark index for which it charges an annual management fee.

Finally, when comparing a mutual fund with its benchmarks – whether it is with an index or its peer group – ensure that you consider the performance of the fund over longer time frames and not just a short time frame. Look at data for one, three, five and even 10-year returns, if available. When a fund consistently outperforms its benchmark indices, it indicates consistency in performance. However, the benchmark performance is one way to choose a fund. In the next article we will consider another question that you need to ask before buying a fund – what risks are involved to try and achieve the performance that you want or need?


The above is for informative purposes only and should not be construed as an offer to sell or solicitation of an offer to subscribe for or purchase any investment. The information provided is subject to change without notice and does not constitute investment advice. MeDirect Bank (Malta) plc has based this document on information obtained from sources it believes to be reliable but which have not been independently verified and therefore does not provide any guarantees, representations or warranties.


MeDirect Bank (Malta) plc, company registration number C34125, is licensed by the Malta Financial Services Authority under the Banking Act (Cap. 371) and the Investment Services Act (Cap. 370).

The financial instruments discussed may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding the appropriateness of investing in financial instruments or implementing strategies discussed herein.

If you invest in any of the products discussed you may lose some or all of the money you invest. The value of your investment may go down as well as up. A commission or sales fee may be charged at the time of the initial purchase for an investment and may be deducted from the invested amount therefore lowering the size of your investment. Any income you get from this investment may go down as well as up. This product may be affected by changes in currency exchange rate movements thereby affecting your investment return therefrom. The performance figures quoted refer to the past and past performance is not a guarantee of future performance or a reliable guide to future performance. Any decision to invest in a mutual fund should always be based upon the details contained in the Prospectus and Key Investor Information Document (KIID), which may be obtained from MeDirect Bank (Malta) plc.

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