Two-tier benchmark
Also written Two-tiered benchmark · Two-tier benchmarking structure · Two-tiered structure for benchmarking · Tier-1 benchmark · Tier-2 benchmark · First-tier benchmark · Second-tier benchmark
SEBI's structure giving certain mutual fund schemes two benchmarks: a Tier-1 index standing for the scheme's category, and a Tier-2 index standing for the fund manager's style or strategy within that category.
In plain language
A scheme has to be measured against something. For some schemes SEBI decided that one index was not enough, so it asked for two.
The first-tier benchmark stands for the category of the scheme. A large cap fund is judged against a broad market index built for large cap funds. That makes two large cap schemes far easier to compare.
The second-tier benchmark stands for the style the fund manager actually follows inside that category. One large cap manager may chase fast-growing shares. Another may hunt cheap ones. A bespoke index can show that difference.
So the two tiers answer two different questions. Did the scheme beat its category? And did the manager beat other people doing the same thing?
Not every scheme gets two. Several types get a single benchmark, and the rule says which.
How it works
SEBI notified the structure by circular dated 27 October 2021, in force with effect from 1 January 2022. Its stated purpose is to standardise and bring uniformity into scheme benchmarks. All the benchmarks followed will necessarily be Total Return Indices — there is no price-return tier.
| Scheme type | Tier-1 | Tier-2 |
|---|---|---|
| Income / debt oriented | One broad market index per index provider for each category, e.g. NIFTY Ultra Short Duration Debt Index or CRISIL Ultra Short Term Debt Index for the Ultra Short Duration Fund category | Bespoke to the investment style or strategy, e.g. an AAA Bond Index |
| Growth / equity oriented | One broad market index per index provider for each category, e.g. S&P BSE 100 Index or NSE 100 Index for the Large Cap Fund category | Bespoke to the investment style or strategy, e.g. the Nifty 50 Index |
| Hybrid and solution oriented | A single benchmark — the broad market benchmark where available, or one created bespoke and then applied across the industry | — |
| Thematic and sectoral | A single benchmark, because the characteristics of such schemes are already tapered to the theme or sector | — |
| Index funds and ETFs | A single benchmark, because these schemes replicate an underlying index | — |
For open-ended debt schemes the first-tier benchmarks follow the Potential Risk Class, and AMCs were to implement that with effect from 1 April 2022.
The tiers are not decorative. Chapter 11 section 11.7.4 makes the Information Ratio the only risk-adjusted return measure an AMC is obliged to disclose, daily on its own website and in comparable format on AMFI's — and for that calculation the benchmark must be the tier-I benchmark used for the scheme, as disclosed in the SID, with the standard deviation of excess returns computed on daily return values. SEBI standardised both the method and the disclosure by circular SEBI/HO/IMD/IMD-PoD-2/P/CIR/2025/6 dated 17 January 2025.
A worked example
Take a large cap equity scheme with Rs 9,000 crore of net assets. Under the structure its Tier-1 benchmark is a broad large cap index such as the NSE 100 TRI, and its Tier-2 benchmark is a style index such as the Nifty 50 TRI.
Over a financial year (returns illustrative):
| Measured against | Index return | Scheme return | Verdict |
|---|---|---|---|
| Tier-1: NSE 100 TRI | 13.20% | 14.10% | ahead by 0.90 pp |
| Tier-2: Nifty 50 TRI | 14.60% | 14.10% | behind by 0.50 pp |
Both rows are true at once, and that is the point of the structure. Against the category the manager added 0.90 percentage points, which on Rs 9,000 crore is about Rs 81 crore of value. Against the style she actually followed — a portfolio tilted to the largest 50 names — she gave up 0.50 percentage points, or about Rs 45 crore.
A candidate assessing the manager needs the second row. An investor choosing between two large cap schemes needs the first.
And when the AMC publishes the mandatory Information Ratio for this scheme, it must compute it against the Tier-1 figure, so the number the public sees is built on the 0.90 percentage points, not the shortfall against Tier-2.
Why NISM asks about it
Chapter 11 (Mutual Fund Scheme Performance), in the section on principles concerning benchmarks of mutual fund schemes, with the tier table; and section 11.7.4, which ties the mandatory Information Ratio to the tier-I benchmark. Expect recall on what each tier represents, on the 27 October 2021 circular and its 1 January 2022 effective date, on which scheme types get only one benchmark, and on which tier the Information Ratio uses.
Common exam traps
- Tier-1 is the category; Tier-2 is the style or strategy. Swapping them is the standard wrong answer.
- Both tiers must be Total Return Indices. There is no price-return tier anywhere in the structure.
- Only income/debt and growth/equity schemes get two. Hybrid, solution-oriented, thematic, sectoral, index funds and ETFs get a single benchmark.
- The Information Ratio uses the tier-I benchmark, not tier-2, and its standard deviation of excess returns is computed on daily values.
- Two dates, both examinable. Circular 27 October 2021, effective 1 January 2022; for open-ended debt schemes the tier-1 benchmarks follow the Potential Risk Class from 1 April 2022.
- A single benchmark is not a failure to comply. For a sectoral scheme it is the rule, because the scheme is already tapered to its sector.
- The two-tier structure is about which indices, not about who chooses them — see Benchmark for the AMC-and-trustees decision and the standard-benchmark disclosure.
Check yourself
1.Under SEBI's two-tier benchmark structure, which scheme categories have only a SINGLE benchmark?
- a)Debt and equity schemes
- b)Hybrid and solution-oriented schemes, thematic/sectoral schemes, and index funds and ETFs
- c)Only index funds and ETFs
- d)All categories have two tiers
Show the answer
Answer: (b) Hybrid and solution-oriented schemes, thematic/sectoral schemes, and index funds and ETFs
Hybrid and solution-oriented schemes, thematic and sectoral schemes, and index funds and ETFs each have a single benchmark.
The reasoning is consistent. For thematic and sectoral schemes, the characteristics are already tapered according to the theme or sector — there is little room for a distinct manager style within a banking fund. For index funds and ETFs, the schemes replicate an underlying index, so a second tier would be meaningless.
Debt and equity schemes carry two tiers: Tier 1 is a broad market index per provider for each category, and Tier 2 is bespoke to the fund manager's investment style or strategy within that category.
For Fund of Funds: a single underlying fund → that scheme's benchmark; multiple schemes → Broad Market Index.
And across all of it: all benchmarks followed will necessarily be Total Return Indices.
2.From which date are mutual fund schemes benchmarked to the Total Return variant of an index?
- a)1 April 2016
- b)1 February 2018
- c)1 January 2022
- d)1 April 2023
Show the answer
Answer: (b) 1 February 2018
With effect from 1 February 2018, mutual fund schemes are benchmarked to the Total Return variant (TRI) rather than the Price Return variant (PRI).
PRI captures only capital gains of the constituents; TRI also takes into account all dividends and interest payments generated by them.
Do not confuse this date with 1 January 2022, when the two-tier benchmark structure came into force following SEBI's circular of 27 October 2021.
Where this is taught
Free preparation for NISM Series V-ARelated terms
- BenchmarkThe independently published index a scheme's performance is measured against, chosen to match its investment objective, asset allocation and strategy, and disclosed in the Scheme Information Document.
- Information RatioActive return over the benchmark divided by tracking error — how much outperformance a manager delivers for each unit of risk taken by deviating from the index.
- Potential Risk Class (PRC) matrixSEBI's grid for classifying a debt scheme by its maximum interest rate risk (Macaulay Duration) and maximum credit risk (Credit Risk Value), disclosed so investors know the ceiling the fund manager may take.
- Price Return IndexThe variant of a market index that captures only the price movement — the capital gains — of its constituents, leaving out dividends and interest. Mutual funds were benchmarked to it until 1 February 2018.
- Total Return IndexThe variant of a market index that adds the dividends and interest paid by its constituents to their price movement — the only variant a mutual fund scheme may be benchmarked against since 1 February 2018.
- Standard benchmarksA fixed, SEBI-specified benchmark for each scheme category — Sensex or Nifty for equity, the 10-year GOI security for most debt schemes — disclosed alongside a scheme's own chosen benchmark for comparison.