Benchmarks are independent portfolios and a representation of behavior of returns from the market. Benchmarks are not managed by fund managers. In simple words, a standard for evaluating the performance of mutual fund investments. To better understand the concept of benchmark it is very important to know the job of a mutual fund. For example, the S&P CNX Nifty is a portfolio of 50 securities traded on the National Stock Exchange. The BSE Sensitive index is a portfolio of 30 securities traded on Bombay Stock Exchange. The movement of these indices represents the movement in prices and returns on the stock traded in the equity market. Suppose an investor invests in an index fund -he will compare the return from index fund with the return from the equity market. If the fund manager is managing an equity portfolio, which invests only in equity but is not an index fund, investors may want to know his performance compares with an independent portfolio like the Nifty or the Sensex. These independent portfolios which are used to monitor mutual fund performance are called benchmarks.
The benchmark for every kind of mutual fund scheme could be different. It is more important that the benchmark portfolio matches the mutual fund portfolio in objectives and is representative of the returns and risk of the market in which the mutual fund portfolio is invested. For example, if the objective of mutual fund is to invest only in information technology stocks, the appropriate benchmark is an index of technology stocks rather than broad market index. If the mutual fund invests 50% of its fund only in equity and the rest in debt, the benchmark should also be a combination of an equity index and a debt market index in the same proportion. If the mutual funds invest in money market, the benchmark should comprise of money market instruments. Thus, it is important that benchmarks that are chosen for evaluating the performance of the mutual funds are appropriate.