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April 27, 2018

Total Returns Index, a more accurate benchmark for mutual fund investors

In keeping with its aim to institute best practices in the Indian mutual fund industry, the regulator Securities and Exchange Board of India (Sebi) has mandated that with effect from February 1, 2018, all mutual funds must benchmark the performance of their schemes to total return indices instead of the simple price return indices that they have traditionally followed. This article explains what is a total return index (TRI) and looks at how its use as a benchmark will increase transparency for investors and the mutual fund industry.


What is a TRI?


Mutual funds in India have traditionally benchmarked their schemes to a simple Price Return Index (PRI), which captures only the changes in the prices of the securities that constitute the index. For instance, the popular S&P BSE Sensex is based on the shares of 30 companies and hence, its returns are measured on the price movements of these constituent stocks.


To enable investors to better assess the performance of a mutual fund scheme versus its chosen benchmark, Sebi has mandated that fund houses must now benchmark all schemes against a TRI. Unlike a PRI, the TRI captures both the capital gains as well as the dividend receipts from the index’s constituent securities. It is assumed that the dividend receipts are reinvested into the index.


Since a mutual funds’ net asset value (NAV) reflects both the capital gains and losses in its portfolio as well as the dividends received from its portfolio holdings, the TRI is a more appropriate and accurate benchmark of its performance. Globally, mutual funds are benchmarked against a TRI as best practices. India will now follow suit. Thus, if a scheme was benchmarked against the S&P BSE Sensex earlier, it will be benchmarked against the S&P BSE Sensex TRI now as per the Sebi mandate.