Mutual Funds – Measuring their performance

What is the issue?

Recently, two fund houses “DSP Black Rock and Edelweiss”, decided to use the Total Return index to measure their performance.

What is the background?

• For long, most equity mutual funds in India have found it quite easy to stay ahead of the index to which they are benchmarked.
• While credit must go to skilled fund managers, a part of it must also go to the funds choosing easy benchmarks.
• Most Indian funds measure themselves up against pure Price Indices, as opposed to Total Returns indices - TRIs.
• While recently two new fund houses have switched to TRIs, “Quantum Mutual Fund” has been doing this for years.

What is TRI?

• An investor in shares makes returns from both the appreciation in the traded price of the share and the dividends received on it.
• A Total Return Index is a benchmark that captures both the price movements and the dividend payouts of its constituent stocks.
• But in India, the default stock index used is the Price Index, which ignores the dividend component.
• So, if the Nifty50 shoots up by 200 points for the day, it is the “Nifty50 Price Index” that is being referred to.
• A sensible investor owning the Nifty50 should actually be tracking the moves of the Nifty50 Total Returns Index, which also factors in the dividends received.
• The NSE actually disseminates both Plain Price & Total Return Indices for all the benchmarks available on the exchange.
• The Nifty50 Total Returns Index is calculated by assuming that the dividends declared by the Nifty50 companies are reinvested in their respective stock, on the day they go ex-dividend.

Why is it important?

• Dividend payouts is not a source of big returns in itself.
• But if it is reinvested over time, this can make quite a significant difference to the investor’s returns.
• In the five-year period between 2012 & 2017, the Nifty50 Index delivered a 13.5% annual return based on price gains alone.
• While the Total Returns for the same period, after assuming re-investment of dividends, works out to 15.2% per annum.

Why haven’t the money managers moved to Total Returns?

• Money managers have persisted with “Price Returns” inorder to help them lower the bar on the returns they need to make to outperform the market. 
• The gap between “Price Returns” and “Total Returns” helps them achieve the same.

Source: Businessline