Is Total Return Index a better benchmark for mutual fund schemes?

Is Total Return Index a better benchmark for mutual fund schemes?

Mutual Fund  schemes have been benchmarking their performances with various indices as the regulations require them to do so. Benchmarking helps in comparing the performance of the scheme with the respective index and tells how much alpha the scheme has generated. It also indicates about the performance of the fund manager.

Currently, all the  mutual funds barring Quantum benchmark their schemes against simple price index which capture only the change in price of the stocks that constitute the index. DSP Black Rock Mutual Fund has recently announced that it will be benchmarking all its actively managed equity schemes with Total Return Index (TRI).

Total Return Index is basically an index which captures both the movement in the stock price of the underlying companies as well as the dividend paid by the companies to the investors.

Therefore, it reflects the true returns accruing to the investors over a particular period while a simple price index will give only reflect the price changes of the index and the capital gains arising out of it.

Comparing with a price index will give a sense of generating higher alpha which may not be give the true picture to the investors.

Nifty 50 price index’s return over the past one year  (as on August 31, 2017) is 13.02 per cent while that of Nifty Total Return Index is 14.48 per cent. So, if a mutual fund is benchmarked against Nifty 50 price index, it will show higher alpha generated than in case of Nifty Total Return Index.

Kalpen Parekh, President, DSP BlackRock Investment Managers said, “Our move to disclose returns against TRI will help in giving the right picture of the real alpha generated by active fund management. The alpha that is shown currently may look overstated as dividends are not added in benchmark returns. By comparing a fund’s performance against a Total Returns Index, funds would be adopting a higher standard of reporting which in turn increases the level of transparency to investors.

“At a time like this, when we are seeing very high flows, we want our investors to have a true picture of the alpha generated and also to have the right expectations from their investments. We feel benchmarking to TRI is a step towards responsible and transparent communication with our advisors and investors and also sets high standards in investment management,” he added.

Kaustubh Belapurkar, Director Manager Research, Morningstar Investment Adviser India, believes, “This is a move in the right direction. Mutual funds investing in stocks, benefit from both the price movement as well as dividends being paid out by the stocks. Comparing the fund performance to the Total Returns index is a fair and transparent mechanism for capturing the true alpha that is being generated through active management. While this will reduce the perceived alpha being generated, it will give investors a better comparison and truer picture of how their investments are performing.”

He also believes that more fund houses are likely to follow the same practice.