Construction of Appropriate Benchmark Index for Mutual Funds - An Empirical Analysis with Specific Reference to Tax Saver Funds (ELSS)

Abstract

Evaluating the performance of mutual funds in the light of increased competition has become more significant in the capital market. Proper identification of investment style and performance measurement of mutual funds have been analysed to facilitate the investment decisions of investors. The performance of mutual funds are analysed by considering various risk related characteristics and also evaluated against the performance of a benchmark index that typically represent the investment style of the mutual funds. If the fund performance is evaluated against an inappropriate benchmark index then the augmentation derived from the analysis may not be appropriate. Hence, the prominent objective is to determine the appropriate Benchmark Index that consists of appropriate asset classes of securities pave the way for precise estimation. The study considers Tax Planning (Equity Linked Savings Scheme-ELSS) funds and selected indices of National Stock Exchange and Bombay Stock Exchange. The methodology focuses on estimating the risk adjusted abnormal return generated by the fund that exhibits the predictive ability (Jensen’s Alpha) of the fund manager through Capital Asset Pricing Model (CAPM) and estimating the Tracking Error Volatility (TEV) of excess daily returns between fund and benchmark. The study revealed that broad based indices that consist of Large cap, Mid cap, and Small cap asset classes would be a appropriate benchmark for evaluating the performance of ELSS funds. Keywords: CAPM, ELSS, Fund performance, Jensen’s Alpha, TEV.

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