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Mar 20, 2017 06:59 PM IST | Source:

SEBI mulling guidelines to review mutual fund benchmarks

The country's markets regulator is considering a Total Returns Index for benchmarking equity mutual fund schemes. Currently, equity schemes are benchmarked against exchange provided indices Sensex and Nifty.

The Securities and Exchange Board of India is mulling a review of performance benchmark index for mutual fund schemes, sources told Moneycontrol.

The country's markets regulator is considering a Total Returns Index for benchmarking equity mutual fund schemes. Currently, equity schemes are benchmarked against exchange provided indices Sensex and Nifty.

According to sources, SEBI’s argument for bringing a new index is that while computing the net asset value of any scheme it takes into consideration the valuation of security plus and also needs to factor in the dividend or the corporate announcement.

Say an equity scheme is benchmarked against the Nifty. Suppose the Nifty has given 8 percent and the scheme has delivered 10 percent return in one year. Within this scheme, return 1.5-2 percent dividend yield is also included. So, when the Net Asset Value performance is compared to Nifty, it is misleading as it does not consider the dividend yield.

This means SEBI may change a methodology to calculate NAV of an equity scheme. Also, these guidelines will be in line with global standards as SEBI gradually intends to move towards uniform calculation standards adopted overseas. As per Global Investment Performance Standards or GIPS, all portfolios must be valued in consonance of fair valuation.

In 2012, SEBI had amended regulations to incorporate the fair valuation norms, which prescribes that "in order to ensure that there is fair treatment to all investors, including prospective investors, the portfolio should be valued on the principles of fair valuations and it should be reflective of the realizable value of the assets".

The SEBI regulations also prescribed that a uniform method should be used to calculate Total Returns.

However, the industry experts have a different argument on the proposed index.

They say, making a Total Returns Index formula may drive it from principles to prescriptive approach. But prescriptive formula may not be suitable for all market conditions.

In total returns index, it assumes that the figure representing returns, is a measure after all dividends are re-invested. However, the practice of dividend distribution is not uniform across all equity mutual fund schemes. A few schemes also have the dividend option and a few have only growth option.

A total returns index may not be a uniform measurement for both the dividend and growth schemes. While total return index will more aptly represent portfolio stocks that regularly issue dividends, some Nifty stocks may not issue dividends, whereas a total return index assumes all stocks issued dividends. If a regulator decides to go ahead with Total Return Index, it needs to address this dichotomy to avoid confusion among investors.

Further, it remains to be seen whether the National Stock Exchange and the Bombay Stock Exchange will follow suit and make a total returns index on Nifty and Sensex public and transparent on a daily basis to enable the fund industry have a transparent benchmark provided by exchanges. SEBI may have to address the issue with the exchanges.

In the reform of mutual fund regulations in 2012, when realisable value of assets was installed as the fair value principle, this was the over-riding principle for all valuations. Thus, re-prescribing a standard formula will take the situation back to the prescription days again rather than the principle-based days (Principle based regulation is high on IOSCO agenda in developed markets).

IOSCO is International Organisation of Securities Commission.

To conclude, if a total return index is prescribed, the actual total returns for each equity portfolio may be different. So, will a single formula based Total Returns Index do justice to all schemes in that category? That is the question that SEBI has to consider
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