MF Benchmarking

Will the Total Returns Index really be a better measure?

Recently, SEBI has been calling upon Indian mutual funds to shift their method of benchmarking mutual fund performance. The regulator has been asking mutual funds to benchmark their fund performance based on the Total Returns Index (TRI) as against the Absolute Returns Index (ARI) that is being followed right now. Let us first understand this difference a little better in the current context…

TRI versus ARI… 

The current focus of Indian mutual funds is to assess performance based on the ARI. The ARI calculates the absolute difference between the index values between two points. For example if the Nifty was at 8000 on Jan 01st 2016 and it was at 9000 on Jan 01st 2017, then the 1-year return for the benchmark index will be considered to be 12.5%. The performance of an equity fund will now be judged with reference to this return. So, if a fund had generated a return of 15.5% in the last one year, then the fund would be deemed to have outperformed the benchmark by 300 basis points. The TRI also considers the return impact of corporate actions like dividends into the calculation. Let us impute that in the above example. Let us assume that the Nifty also had a dividend yield of 1.50% during that period. Therefore, as per TRI, the fund outperformance will not be 300 basis points but just 150 basis points. TRI, thus, makes the picture more realistic.

Does it really add value? 

To begin with, it does add value! In fact, Quantum Mutual Fund has always followed TRI while the much more formidable DSP Blackrock MF is also shifting to the TRI methodology. What TRI does is to put the alpha (excess returns) that fund managers claim, in a better perspective. It is also a case of comparing apples with apples as your fund NAV includes the dividend received. Therefore, the benchmark should also rightfully include the dividends in their calculation. The answer is that it will put Alpha in a much better analytical context!

But there are practical challenges…

Dividends are not exactly a uniform income for all recipients as it is taxed at different rates depending on the size of the dividend. That complicates the benchmark. Secondly, more and more companies are paying corporate benefits in the form of share buybacks rather than via dividends as buybacks are more tax-efficient. The wealth effect of a buyback will depend on whether the offer is accepted or not and that will complicate the calculation. So, when these practical challenges are added up, the shift to TRI may not really add value. It may be easier for funds to provide the dividend yields on the index and leave it to investors to decide. It looks like the shift to TRI could actually complicate matters for investors! ©


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