What is Total Return Index and How Does It Help You to Accurately Track Your Mutual Fund Investments?
Mutual funds are among the most trusted investment products available to Indian investors. These investment instruments offer both flexibility as well as a phenomenal potential to earn returns. The Securities and Exchange Board of India (SEBI) and the Association for Mutual Funds in India (AMFI) often work in tandem to create awareness about mutual funds among investors and to encourage them to invest in mutual funds.
SEBI is known for taking proactive measures towards making such investments more transparent and easy-to-understand for investors. Last year, the securities and investment regulator directed all mutual fund houses to categorize their schemes into five broad categories – equity, debt, hybrid, solution-oriented, and others. The initiative is aimed at streamlining the mutual fund industry and making it easier for investors to choose schemes. Effective from 1st February 2018, the Price Return Index (PRI) has been replaced by the Total Returns Index (TRI) and mutual fund houses are required to compare their schemes with the latter.
What is Total Return Index (TRI)?
At present, all mutual fund schemes, except debt schemes, are compared with the PRI. PRI is a comparative tool to calculate the return generated by a particular mutual fund scheme.
The mutual fund returns may be generated in two ways—capital gains and dividends. Using PRI as a benchmark, however, does not provide an accurate picture of the returns generated. This is because PRI only accounts for capital gains generated by the index constituents. The dividends earned by the scheme are not part of the calculation in this case.
The Total Return Index, on the other hand, in addition to the capital gains, considers all dividends or interest payments that are generated by the constituents of the index. Therefore, it shows the complete picture to investors to help them compare mutual fund returns.
How does the Total Return Index affect your mutual fund investments?
On an average, the constituents of the index earn around 1.5% dividend or interest per annum. This return is not reflected in the PRI that mutual fund schemes are currently compared to. Since the PRI ignores the dividend or interest payouts, it understates its returns by around 1.5% every year. Now, with SEBI’s new guideline, investors will notice the index performance go up by around 1.5% since PRI will be replaced by TRI.
Consider an example to understand this concept better. Say you invested in a particular scheme, which claimed to beat the index by 3% in a year. That outperformance will now be reduced to 1.5%. This is because, till date, mutual fund schemes would factor their dividend payments into the net asset value (NAV) of the fund to drive up the returns against the benchmark. If your mutual fund house was using Sensex as a benchmark index earlier, it will use Sensex TRI from 1st February 2018.
Replacing PRI with TRI is unlikely to have any adverse impact on your mutual fund investments. The only change will be that your mutual fund house will need to work harder to ‘outperform’ the index in terms of returns. The good news is that your money will not be able to slack off and hide behind inaccurate benchmarks anymore.
The investor community often breaks into a frenzy when new moves like this one are made by SEBI. However, there is no reason to press the panic button just yet. This initiative is meant to make mutual fund investments more convenient for investors. After the initial jitters, the industry is expected to make a smooth transition to the new system of benchmarking. Another signal of relief to investors is the market regulator’s plan to bring down the administrative costs for your investments. This would work in favor of investors by boosting their returns on mutual funds.
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