Absolute-return benchmark
Also written Fixed-rate benchmark
A fixed percentage return, set by the manager when the scheme launches, against which an absolute-return strategy is judged instead of a market index.
In plain language
Most funds are measured against an index. If the market fell 15 per cent and the fund fell 10 per cent, the manager did well.
An absolute-return strategy rejects that logic. It aims to make money independently of which way the market moved, so measuring it against the market answers the wrong question. Instead the manager fixes a number at launch — say 10 per cent a year — writes it into the scheme documents, and is judged over or under that line. Beat it and the fund over-performed for the year; miss it and it under-performed. There is no adjusting for what the Nifty did.
How it works
Chapter 7 explains why AIFs need this at all. Funds differ so widely in asset class, use of derivatives and leverage that constructing one benchmark per category is impractical. Where a fund invests in listed securities, the manager can fall back on a broad-based NSE or BSE index matched to the market capitalisation the strategy targets — an indicative benchmark, the workbook says, if not a perfect one.
Absolute-return strategies cannot use even that. They run leveraged, concentrated, long/short or market-neutral positions in equity, commodity and index derivatives and other unconventional methods, so index-relative reporting is meaningless. The benchmark is therefore a pre-determined fixed rate, and returns may be computed over shorter intervals — monthly or quarterly — as well as annually.
Category I and II AIFs sit in a different bind again: they hold unlisted securities and early-stage start-ups, so no broad index applies, and a thematic fund does not compare with a sector-agnostic one. There the common answer historically was the Public Market Equivalent (PME), and the formal answer now is the SEBI-mandated benchmarking agencies — CRISIL, NSE and Preqin, notified through IVCA — which build vintage-year benchmarks from pooled IRR, investment multiples, DPI, RVPI and TVPI.
A valid benchmark, by the GIPS criteria the workbook reproduces, must be specified in advance, relevant, measurable, unambiguous, representative of current investment options, accountable, investable and complete.
A worked example
An absolute-return scheme launches with Rs 400 crore and a benchmark fixed at 10 per cent a year in the placement memorandum.
| Year | Scheme return | Fixed benchmark | Verdict | Broad index |
|---|---|---|---|---|
| 1 | +14% | 10% | Over-performed | +22% |
| 2 | +6% | 10% | Under-performed | −11% |
| 3 | +11% | 10% | Over-performed | +9% |
Year 2 is the point of the whole idea. The scheme made Rs 24 crore while the index lost 11 per cent, and against any index-relative benchmark the manager would be reporting a spectacular year of outperformance. Against its own stated 10 per cent it fell short, and it reports under-performance.
Year 1 cuts the other way: Rs 56 crore of gains and a comfortable pass, even though an index fund would have returned Rs 88 crore.
That is the trade the investor knowingly buys — returns uncorrelated to the market, measured against a number rather than against the market.
Why NISM asks about it
Chapter 7 (Fund Performance and Benchmarking of AIFs), section 7.5 and the run-up to section 7.5.1, plus Box 7.2 on what makes a benchmark valid. Expect a question on why a Category I or II AIF cannot be benchmarked to a broad-based index, and one asking what an absolute-return strategy is benchmarked against — the answer is a pre-determined fixed rate, not an index.
Common exam traps
- Absolute-return benchmarking is not the same as having no benchmark. The rate is fixed in advance and disclosed; it just is not an index.
- It is set by the manager at launch, not negotiated each year and not reset when markets move.
- Do not confuse it with the hurdle rate. The hurdle decides when a fee becomes payable; an absolute-return benchmark decides whether performance is reported as over or under. A fund can clear one and miss the other.
- The absolute-return description in Chapter 7 sits with leveraged, long/short and market-neutral strategies. Category I and II funds reach for PME and the benchmarking agencies instead.
- Benchmarking agency reporting is on pre-tax NAV, half-yearly on 30 September and 31 March data, only for schemes that have completed a year from first close. March data must be audited; September may be unaudited.
- Chapter 7 points to "Box 10.5" for the operational guidelines when the box in front of you is numbered 7.3, and its footnote sends you to "section 9.8.5" of Chapter 9 for PME. Those cross-references are printing errors; the content is in Chapter 7.
Where this is taught
Free preparation for NISM Series XIX-DRelated terms
- Net Asset ValueThe net assets of a mutual fund scheme divided by the number of units outstanding — what one unit of the scheme is worth on a given day, after every liability except the unitholders' own.
- Hurdle rateThe minimum return that must accrue to investors before the manager earns any incentive fee — the threshold that turns a fund's profit into the manager's profit.
- Distributions to Paid-in CapitalCumulative cash actually distributed to investors divided by the capital they have paid in — the realisation multiple, and the one return measure a fund cannot flatter with its own valuations.
- Economic Internal Rate of ReturnThe IRR of a project widened to include the direct and indirect economic benefits it creates, whether or not they reach the fund — as distinct from the financial IRR the fund actually earns.
- Reference Hurdle NAVThe rupee NAV a close-ended AIF must reach before any incentive fee is earned — called-up capital compounded forward at the hurdle rate, year after year.