You cannot compare apples to oranges, as they say. Would you look at the revenue and profit growth of Infosys and compare it to, say, BHEL or Larsen & Toubro? No. That’s because Infosys and L&T are in two completely different industries and influenced by a completely different set of drivers. Would you compare Infosys to TCS or Wipro? Absolutely! They all are in the same sector and have similar growth opportunities and challenges, so you would be able to draw a conclusion on Infosys’ performance.
For this same reason, when looking at the performance of a fund, you need to compare it to similar funds only. Read any of our fund reviews, and you will fund at least one mention of the fund’s performance against its category.
What is it?
A fund’s category is defined by the type and range of securities it holds in its portfolio. A fund that puts the majority of its portfolio in large-cap stocks is a large-cap fund. A fund that is flexible in its allocation to large-cap and mid-cap stocks is a diversified fund. Similarly, you will have sector funds (banking, pharma, infrastructure, etc).
Besides pure equity and debt fund categories as explained above, hybrid funds are separate categories as well. You, therefore, have equity-oriented balanced funds and MIPs as two distinct categories.
How is it useful?
Take 2015. In that year, the Nifty 100 index was down 2.5 per cent. Birla Sun Life Frontline Equity, a large-cap fund delivered a return of 1.1 per cent for that year. The Nifty Midcap 100 rose 6.2 per cent. Mirae Asset Emerging Bluechip, a mid-cap fund, returned 14 per cent for 2015.
Would you conclude that BSL Frontline Equity is a bad fund and Mirae a good one in 2015? No, because large-cap stocks had an insipid 2015 while mid-cap stocks had a roaring time. BSL Frontline Equity, because it invests only in large-caps, cannot gain from the rally in mid-caps. Mirae Emerging Bluechip did very well because it invests in mid-caps and not in large-caps.
This is why comparison of a fund’s performance is possible only within its category. In 2015, the large-cap fund category lost 0.55 per cent on an average. That is, the average return of all large-cap funds was a negative 0.55 per cent for 2015. So BSL Frontline Equity did better than the average and its benchmark, and thus performed well.
In a nutshell, a fund (whether equity, debt, or hybrid) should be able to beat its category average on a consistent basis for it to be called a good performer.
Blog source: http://www.fundsindia.com/blog/mutual-funds/fundsindia-explains-what-is-a-fund-category/8915