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Markets regulator Sebi recently brought in a two-tiered structure for benchmarking of mutual funds to standardize benchmarks of schemes. The first-tier benchmark is as per the category of the scheme, and the second tier, which is optional, reflects the investment style of the fund manager. For first-tier benchmarks of income/debt-oriented and growth/equity-oriented schemes, the regulator has suggested one broad market index per index provider for each category. For the second-tier benchmarks of these two categories, there can be a bespoke benchmark of the index.

For hybrid and solution-oriented schemes, there would be a single benchmark, i.e., broad market benchmark wherever available or bespoke to be created for schemes, which would then be applicable across industry. The tier-1 benchmark allows comparison of performance of a fund to the underlying benchmark, which could be a total return index (TRI) of CNX Nifty or BSE Sensex. As per the new regulations, asset management companies are allowed to get an additional tier-2 benchmark, which reflects the stock selection, style and riskiness of the fund manager. For example, a research firm can make a bespoke benchmark index as per the investment strategy and style for a scheme of a fund house. Experts believe that the tier-2 benchmarking can help investors understand what to expect from the fund.

“Investors know that we will not be deviating from the index and taking exposures in AA rated companies. Also, one can back test a construct of the fund to assess the likely performance of the fund for periods when it was not launched. As the fund would follow the tier-2 index closely, the performance of the tier-2 index could be a good proxy of the fund’s performance and volatility," said Sandeep Bagla, CEO, Trust Mutual Fund, which is the first fund house to use the bespoke benchmark indices.

Further, the two-tier scheme benchmarking can be used by debt as well as equity fund managers. In debt management, fund houses could have differentiated schemes regarding, duration, credit, maturity, roll down etc, and each aspect can be properly brought by the tier-2 benchmark.

Further, Bagla believes that in equity, differentiation could be made over market capitalization, momentum, weightage, etc, and alternate benchmarks could be created in equity and hybrid schemes as well to reflect the fund manager style and strategy.

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