In 2012, SEBI or Securities Exchange Board of India made it mandatory for fund houses to declare a benchmark index. A benchmark is based on the objectives of a fund and is independent. It is a standard against which the performance of a mutual fund can be measured.
Benchmarks are created across all types of asset classes. Generally, large-cap equity mutual funds benchmark themselves against the Sensex or the Nifty. Others are benchmarked against CNX mid-cap, CNX small cap and S&P BSE 200. A fund's returns should be compared to its benchmark to understand how a fund has performed.
There are times a scheme would deliver higher returns than the benchmark, in this situation it has outperformed the benchmark, however, if it has delivered returns below the benchmark it’s a clear sign the fund has underperformed the benchmark.
Sometimes over a period of time, the benchmark index falls and at the same time, your fund’s NAV also falls. In this case, you can still say the fund has outperformed the benchmark.
Actively managed funds do charge you a fee for their services so if the performance falls in line with the benchmark, you could say it is has underperformed as it should deliver returns equal to an index fund.
Choosing a fund by comparing its benchmark is one way to choose a fund. A short-term performance isn’t something you should base your decision on. You should look at the long-term returns on the fund before you decide to invest.
A benchmark indicates the fund manager’s performance. If a fund outperforms the benchmark it is an indication of efficiency on his behalf thereby making it a safe investment over a period of time. Before you invest it is important you understand your own risk profile and evaluate your need before making an investment.