Lesson 2 of 8 · Risk, Return & Performance

Benchmark & Alpha — Beating the Index

A benchmark is the index a scheme's performance is compared with, and alpha is the return above what the scheme's sensitivity to that index would predict. This lesson covers SEBI's benchmark rules, the Total Return Index, and how alpha is worked out and read.

Fact-checked 8 October 20263 practice questions in the game

What a benchmark is

A return figure means little on its own. A benchmark is the index against which a scheme's performance is compared, so that the reader can see how the scheme did relative to the part of the market it invests in.

Under SEBI's rules every scheme has a Tier 1 benchmark that reflects its category. A Tier 2 benchmark, reflecting the scheme's particular style, is optional.

Why the Total Return Index

An index can be calculated on prices alone, or as a Total Return Index (TRI) that also includes the dividends paid by the index companies. A scheme receives dividends on the shares it holds, so a price-only index is an incomplete yardstick.

Since 1 February 2018, scheme performance has been compared with the TRI version of the benchmark.

Excess return and alpha

The simplest comparison is the excess return: fund return minus benchmark return. It ignores the risk taken. A fund that tends to move more than its benchmark can be ahead in a rising year for that reason alone.

Beta measures that sensitivity to the benchmark. Jensen's alpha adjusts for it: alpha = fund return − [risk-free rate + beta × (benchmark return − risk-free rate)]. The part in square brackets is the return beta would predict; alpha is whatever the fund earned above or below it.

So a high return does not by itself mean positive alpha. A fund with a high return and a high beta can have zero or negative alpha.

Reading alpha with care

Alpha is measured against a chosen benchmark over a chosen past period, and it changes if either is changed. It can be negative. Persistent negative alpha means the fund lagged what its risk would predict over the period measured. It does not show what future returns will be.

For index funds and exchange-traded funds the aim is to follow the index, so two other measures are used. Tracking error is the annualised standard deviation of the daily difference between the scheme's return and its index over a rolling year. Tracking difference is the annualised difference in returns.

Rules at a glance

Tier 1 benchmarkRequired for every scheme; reflects its categorySEBI Master Circular for Mutual Funds, 20 March 2026

Tier 2 benchmarkOptional; reflects the scheme's styleSEBI Master Circular for Mutual Funds, 20 March 2026

Version of the benchmarkTotal Return IndexSince 1 February 2018

Jensen's alphaFund return − [risk-free rate + beta × (benchmark return − risk-free rate)]Definition

Illustration

Price index and Total Return Index (illustrative)

Assumed figures: in a year a price index rises 10%, and the dividends paid by its companies add about 1.5 percentage points, so the Total Return Index returns about 11.5%.

A scheme that returned 11% in that year is ahead of the price index but behind the Total Return Index. Because the scheme also received dividends on its shares, the second comparison is the like-for-like one.

Worked example

Excess return and alpha for two funds (illustrative)

Assumed figures, for arithmetic only: in one year the benchmark (Total Return Index) returns 15% and the risk-free rate is 7%. Fund P returns 18% with a beta of 1.5. Fund Q returns 14% with a beta of 0.8.
Fund P, simple excess return = 18% − 15% = 3%.
Fund P, return predicted by beta = 7% + 1.5 × (15% − 7%) = 7% + 12% = 19%. Alpha = 18% − 19% = −1.0%.
Fund Q, simple excess return = 14% − 15% = −1%.
Fund Q, return predicted by beta = 7% + 0.8 × (15% − 7%) = 7% + 6.4% = 13.4%. Alpha = 14% − 13.4% = 0.6%.

Result. Fund P was 3% ahead of the benchmark but has an alpha of −1.0%; Fund Q was 1% behind but has an alpha of 0.6%. The two measures can point in opposite directions, and both describe this one period only.

Key points

Every scheme has a Tier 1 benchmark reflecting its category; a Tier 2 benchmark reflecting its style is optional.
Since 1 February 2018, performance is compared with the Total Return Index, which includes dividends.
Simple excess return is fund return minus benchmark return and ignores the risk taken.
Jensen's alpha is the return above what the fund's beta would predict, and it can be negative.
Alpha describes a chosen past period against a chosen benchmark; it does not predict future returns.

Common misunderstandings

A high return does not mean positive alpha: with a high beta, the return may be no more than sensitivity to the benchmark would predict.
Excess return and alpha are not the same thing: excess return ignores beta, alpha adjusts for it.
A Tier 2 benchmark is not compulsory: only the Tier 1 benchmark is required for every scheme.

Questions people ask

What does a Total Return Index include that a price index does not?

The dividends paid by the companies in the index.

Can alpha be negative?

Yes. It is negative when the fund earned less than its beta would predict over the period measured.

Does past alpha show what a fund will earn?

No. It is measured over a past period against a chosen benchmark and does not show future returns.

What this lesson relies on

SEBI Master Circular for Mutual Funds, 20 March 2026 — benchmarks (Tier 1 and Tier 2, Total Return Index), tracking error and tracking difference
Standard definitions of excess return, beta and Jensen's alpha (plain mathematics)

This lesson was reviewed independently against these sources on 8 October 2026. Rules change: check the current regulation, scheme document or policy wording before relying on any figure. This is education, not advice.