The talk of the town in the mutual fund industry recently has been whether or not Total Returns Index (TRI) is the appropriate benchmark for actively managed equity schemes.
When Kalpen Parekh, President, DSP BlackRock Investment Managers, decided to use the Total Returns Index (TRI) as the standard benchmark for all DSP equity funds, he probably did not envisage it spilling over into an industry-wide debate. And now, slowly but surely, the investor community and regulator SEBI alike are considering TRI as a better comparison and return expectation benchmark than a simple price index.
But what is TRI? What is so special about it that it has caused all this buzz? The TRI is a type of equity index that tracks and captures the capital gains of the underlying stocks included in that index. But it also assumes that any cash distributions such as dividends paid out by such stocks are reinvested back into the stock.
The Price Index, on the other hand, considers only the gains that arise from the stock price movements and does not factor in dividends. Only in recent years have the NIFTY and SENSEX indices started providing both the Price Index returns as well as TRI.
How does it affect mutual fund investors?
The TRI will typically perform better than a simple price index. Hence a mutual fund that has benchmarked itself against a TRI will show less ‘alpha’, which is the returns generated over and above the benchmark.
For example, the Nifty 50 TRI from 1st Jan, 2017 to 2nd Nov, 2017 delivered a positive return of 29.01%. Over the the same period, the Nifty 50 Price Return Index delivered only 27.44%. That is a difference of 1.57%. Therefore an equity fund benchmarking itself against a price index will show higher alpha in comparison to one benchmarking against the TRI.
The underlying concept is that by comparing itself against the TRI, an equity fund provides more transparency in its performance records and also pushes the fund manager to better actively manage the fund.
What the supporters have to say about using TRI
Besides bringing out more transparency in terms of mutual fund performance, it is widely believed that using the TRI as a benchmark will help set investor expectations in terms of the alpha generation that they can expect from the product.
In a startling discovery, according to mutual fund data firm Morningstar, after shifting the benchmark from price index to TRI, the number of large-cap funds beating the benchmark dropped from 85% to 58%.
The S&P Indices Versus Active Funds (SPIVA) India Scorecard, maintained by Asia Index Pvt. Ltd shows that over the 1-year period ending June 2017, a 53% of large-cap funds underperformed the S&P BSE 100 TRI.
Globally, TRI is the preferred benchmark, especially in developed markets. In India, most fund houses still prefer using a price return index. If we are truly hoping to achieve the status of a developed market, adopting the TRI now makes more sense than ever.
While it is hard to criticize the concept from an investor’s point of view, certain fund managers believe that it may be premature to bring in such a change into mutual fund industry just yet. At a recently held mutual fund industry conference, Nilesh Shah, Managing Director, Kotak Asset Management Co. Ltd, said that there are practical limitations in adopting TRI.
He added, for example, at any given point, funds keep certain reserves of cash available, while indices do not. Furthermore, indices won’t bear any impact cost for stock adjustments, but fund managers may have to, depending on the size of the transaction and liquidity in the markets. Lastly, the dividend yield in a developing economy like India is generally low. Fund managers generally have a more focused approach towards capital appreciation.
Only time will tell whether the industry will adopt the TRI as a benchmark standard. And while certain hurdles may persist, the surging inflows into equity funds accompanies with high return expectations are strong reasons to accelerate the process.