SEBI is the governing body in India that provides the rules and guidelines with respect to mutual funds. They are one of the most sought-after investment products by investors today. However, to invest in mutual funds, investors also have to learn about their performance and the basis against which it is measured. As per a recent amendment by SEBI, the basis of benchmarking for mutual funds has been changed from Price Return Index to Total Return Index.
Here are more details about the Total Return Index .
What is the Total Return Index?
As per SEBI guidelines, Total Return Index is the measure to be used as a basis for benchmarking for all the mutual funds. This amendment is in effect from 1st February 2018 and has been applicable to all the mutual fund schemes in India.
Total Return Index provides a better picture of the returns of the mutual fund as it considers capital appreciation as well as the dividend payouts.
What is Benchmarking?
A benchmark is the basis for measuring the performance of a mutual fund. It is also an index that is a collection of various securities. These securities are measured at the prevailing market prices and the value of the benchmark is the sum total of all such securities. The price of the benchmark is directly proportional to the prices of the components within and increases with an increase in such prices.
The performance of the fund is compared to the performance of the benchmark. When the fund generates higher returns than the benchmark, it is considered to have performed better and vice versa.
Difference Between Total Return Index and Price Return
The returns generated for any mutual fund are twofold i.e through the dividend payouts and the capital appreciation of the fund. Capital appreciation is the increase in the market price of the security. Until February 2018, Price Return Index was used as a parameter to measure the performance. However, the scope of Price Return Index is limited as it only factors capital appreciation for measuring the performance of the mutual fund. In equity oriented funds especially, the dividend payout is also equally important as reinvested dividends can improve the overall performance of the fund in the long run.
Total Return Index factors in the capital appreciation as well as the dividend payouts to show the true picture of the performance of the fund. This will help the investors in making better investment decisions when comparing two funds. Price Return Index can mislead the investors on account of overstating the returns which may lead to an increased investment in the fund. While comparing the funds on the basis of Total Return Index will give a clearer picture and a similar basis of comparison.
Impact of Total Return Index on investors
The use of the Total Return Index has resulted in showing the true picture of the fund’s performance to the investors. Traditionally, the funds using the Price Return Index would have shown better results as compared to the benchmark but the same may not be the case when Total Return Index is used.
This will help the investors in making better investment decisions as well as choosing the right investment strategy for them. Historical data has shown that the actively managed funds have outperformed their benchmark but with Total Index Return the scenario is changing increasingly and many investors have shifted their focus to passively managed investments. Passively managed funds provide a decent return to the investors without the risk and expense of the actively managed funds.
The change in the benchmarking mode was aimed to provide the investors with a better measure to evaluate their portfolios. Investors have to review their investments correctly so they can remove the underperforming assets with other investments that can give them better returns and are in line with their investment budget and investment goals.
1. What is the advantage of using Total Return Index?
Total Return Index uses the capital appreciation and the dividend payout to evaluate the performance of a fund which provides the correct analysis of the returns to the investors.
2. Since when is the Total Return Index integrated in benchmarking as per SEBI?
Total Return Index is integrated in benchmarking as per SEBI from 1st February 2018.
3. Is using the Total Return Index mandatory to measure the performance of all the mutual funds?
The guideline to use the Total Return Index for measuring the performance of all the mutual funds in India has been issued by SEBI which is the governing body for all the mutual funds in India. Hence the use of Total Return Index is mandatory for all the mutual funds from 1st February 2018.