Sensex and Nifty Indices: Are They the Right Benchmarks for Mutual Funds in India?

Recently two significant developments took place in the Indian capital markets: (a) SEBI’s decision making it mandatory for all mutual funds to disclose the scheme returns against a common benchmark index such as Nifty or Sensex and (b) Employee’ Provident Fund Organisation (EPFO) is permitted to invest a part of their funds into stock market through the exchange-traded fund (ETF) route, particularly SBI Sensex and SBI Nifty ETFs. Both the developments are tied by a common concept that stock market indices such as Nifty and Sensex are passive without any statistically significant alpha. In the fund management industry, alpha is a measure of the risk-adjusted excess returns from a portfolio that can be attributed to the stock-picking skills of a fund manager. In this article, an attempt is made to examine for the presence of significant alphas in the returns of both the indices. The results of the study indicate that both the indices have statistically significant excess returns, raising questions on their suitability to act as reference and/or benchmarks for evaluating performance of mutual funds in India. Further, the study examined the returns of Sensex and Nifty index ETFs and observed a statistically significant alpha. The results of the study have important implications not only for the index construction companies but also to the policymakers who are advocating investment of considerable amounts of provident fund money into stock market through ETFs linked to Sensex and Nifty. Index maintenance companies have to re-design the indices so that they remain passive and the EPFO Administration may rethink their decision to invest in the existing ETFs linked to the Sensex and Nifty indices, and should consider constructing a well-diversified stock portfolio that is truly passive so that their mandate to get exposure only to market risk is fulfilled.