New Benchmark for MFs – TRI

Written by Vidya Kumar

January 17, 2018

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Executive Summary: PRI or Price Return Index was used by MFs to benchmark the performance of their schemes. SEBI has mandated that Total Return Index has to be used. This means the comparison will be against higher index returns. It is good for investors as there will be a proper comparison of returns. MF managers will have to work harder to generate alpha returns. There might be some practical limitations on implementation of the same as per some MF houses.

Mutual funds have to name a benchmark index with which the products can be compared to measure performance of their schemes. Most mutual fund schemes use the benchmark’s PRI. PRI is the Price Return variant of an Index. It captures only the capital gains of the index constituents.
Last week, SEBI mandated that mutual funds have to use the Total Return Index (TRI) as the benchmark for performance of their schemes. The TRI  takes capital gains, dividend and interest payments generated by the index constituents for measuring performance. This means the returns of the index will be shown as higher than earlier and the difference between scheme returns and index returns will be narrower.
SEBI believes it is an appropriate measure for performance comparison for many financial products. In case TRI is not available to compare performance for any particular period, the composite CAGR (compound annual growth rate)  of the performance of the PRI benchmark is to be used. The Mutual funds have to start using TRI from February 2018. 

Nilesh Shah of  Kotak Asset Management Co. Ltd thinks it is a good move for investors but sees some practical difficulties in its implementation. He says that the fund incurs an impact cost at the end of the day and dividend yields are not significant for indices. There are also changes in the index composition often which cannot be mirrored by schemes always. 

Suresh Sadagopan, founder of Ladder7 Financial Advisories says, ‘Total Return index captures not just the returns based on price movement but the total returns which includes interest, capital gains, dividends & distributions. Comparing the fund returns to Total Return index is the right method. However, this will affect Alpha generated over the index by about 150 basis points and would diminish the attractiveness of an actively managed fund. It will become more difficult for actively managed funds to consistently beat TRI. This move by SEBI to make the funds compare their schemes against the TRI is, however, an investor-friendly move as it gives a more realistic indicator of the fund outperformance over the index as opposed to the Price return index’.

​Funds hold cash unlike indices. So there is some amount uninvested in a fund which may not earn returns and therefore comparing fund returns to an index’s TRI may not be the right way.
Quantum Mutual Fund started using S&P BSE 30 TRI as a benchmark more than 10 years ago. Quantum Long Term Equity Fund, an equity scheme of Quantum MF has an annualised return of 15.17% since inception as compared to S&P BSE 30 TRI index annualised return of 11.46% as of , till 31 August 2017. (Source: www.livemint.com).
DSP and Edelweiss are other MF houses that already use TRI.
The move from PRI to TRI means that fund managers will have to manage performance and generate extra returns so that the schemes deliver returns over and above the benchmark. 
Another thing that can happen is that people might switch schemes when they see the returns being lesser as compared to earlier times. They might invest directly in the stock market or in ETFs which might deliver better returns than funds that are actively managed. 

The move is good as customers will be more aware of the differences in TRI and PRI and will be able to evaluate performance of schemes in a better way. But rather than exiting from schemes that show lower returns, one should assess the long-term performance and then make investment decisions.

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