Investors will have clarity on the funds’ performance
By IE&M Research
Securities and Exchange Board of India (Sebi) is mulling a review of performance benchmark index for mutual fund schemes which will prove an extra-ordinary move for the Mutual Fund industry in India.
Sebi wants to shift all the funds to benchmark their performance based on the Total Returns Index (TRI) rather than on the absolute returns index also known as Price Return Index (PRI). Currently, equity schemes are benchmarked against exchange provided indices, Sensex and Nifty.
The difference between TRI and PRI are various corporate benefits that accrue to shareholders such as dividend, rights, buybacks etc. Hence, TRI for the same basket of securities is always going to be higher than the return of the PRI. For example, there is an equity fund that has benchmarked its performance against the Nifty. In last one year Nifty has moved up from 8611 to 9788, giving an absolute return of 13.7 %. The equity fund will be benchmarked based on these returns. A large cap equity funds with an average in the same period has given a return of 14.91%. Therefore, a simple calculation shows that fund would have outperformed the benchmark by 121 basis points.
Nevertheless, the devil lies in detail on how returns are calculated for funds and for Nifty. While the fund’s return includes dividends and all other corporate benefits from the equity stocks that it has been holding, it is not considered in case of benchmark indices like Nifty. In last one year the average dividend yield for Nifty remained at 120 basis points. Considering this as a proxy to dividend distributed by Nifty companies and if we add back to Nifty returns, benchmark returns will be 14.90%, only one shade below fund’s average return.
According to a study done by Morningstar, an investment research and investment management firm, comparison between PRI and TRI in the last five years shows total returns of the S&P BSE 100 is 165 basis points higher every year. This would easily wipe out most of the outperformance shown by the large cap funds in this period.
Hence, shifting of performance comparison to TRI from PRI will present a true picture of returns generated by them. This will also help fund house to establish greater transparency and credibility in communicating performance to its investors. Therefore, as part of good practice some of asset managers (Quantum Mutual Fund, DSP Blackrock Mutual Fund and Edelweiss Mutual Fund) have voluntarily shifted benchmarking their scheme performance to indices based on Total Return Index.
Although, Sebi is yet to make TRI mandatory, the primary beneficiary of any such move will definitely be investors. For investors, this means a more precise performance measure when he considers schemes performance against the benchmark. Nonetheless, if an investor is choosing which fund to invest in based on a peer-group return comparison over a predetermined period, this will not matter in making the selection. This is because, except for the above mentioned asset managers, all fund houses are using PRI to show returns of their funds. Hence, it’s apple to apple comparison.
Shifting to PRI will also push fund managers to try harder to generate alpha and not rely on the technical discrepancies for making excess return. The entire move may also put more focus to high dividend paying stocks.
Therefore, if SEBI implements it or asset managers as part of good practice adopt TRI as a benchmark, there may be a fall in performance of active funds. This may lead to rise of passive funds, which try to imitate the performance of a specified index by buying an index fund. Whatever may be the consequences, investors will be the winner and will have clarity on the funds’ performance that will help them to choose right funds.