Sebi’s new ruling on two-tier benchmarking, which becomes effective from January 1, 2022, aims at bringing uniformity in comparing the performance of mutual fund schemes within a single category.

What Is Two-Tier Benchmark?

• Till now, each scheme had a single benchmark from its category. Now most open-ended schemes will have two benchmarks
• The first-tier benchmark shall be reflective of the scheme’s category. For example, this benchmark will reflect the broader category index, such as the S&P BSE 100 index or NSE 100 index, for large-cap funds
• The second-tier benchmark is optional and can be chosen by the fund house
• It can be a ‘bespoke’ benchmark, chosen by the fund house and demonstrative of the investment style or strategy of the scheme. For instance, for large-cap funds, the fund house could choose the Nifty 50 index
• Thematic or sectoral schemes, index funds and exchange-traded funds will have a single benchmark

How Does It Work?

• A benchmark is the point of reference or an index against which the performance of a fund or scheme is measured
• For instance, a large-cap fund is benchmarked against NSE Nifty 50  BSE Sensex and a small-cap fund is benchmarked against BSE Small cap or CNX Small cap index
• There are specific indices available for second-tier benchmarking. For instance, the ultra short-term fund category will have Nifty Ultra Short Duration Debt Index or the Crisil Ultra Short-Term Debt Index as the first-tier index and AAA Bond Index as the second-tier bespoke index
• Similarly, for large-cap equity schemes, S&P BSE 100 Index or NSE 100 Index will be the first-tier index and Nifty 50 Index could be the second-tier index

How Will It Help?

• Experts believe that the new directive will help investors gauge their fund’s performance more accurately
• An analysis of major equity- and debt-oriented schemes showed that despite uniformity of scheme classification brought in by the regulator in 2018, there is still too much variation in benchmarking within a category
• For instance, even within large-cap funds that limit their investments to the top  100 listed stocks by market cap, the underlying schemes are using four unique benchmarks
• The regulator’s move will bring in uniformity in terms of performance comparison for schemes within a single mutual fund category, especially within open-ended equity and debt-oriented schemes