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Mar 20, 2017 04:54 PM IST | Source:

SEBI working on guidelines to review mutual fund benchmarks

Himadri Buch

The capital market regulator, Securities and Exchange Board of India, is mulling a review of performance benchmark index for mutual fund schemes, according to the sources in the industry.

SEBI is contemplating linking mutual fund schemes to total returns indices for benchmarking equity mutual fund schemes. Currently, equity schemes are benchmarked against primary indices provided by exchanges, such as Sensex and Nifty, which are typically principal returns indices.

SEBI’s argument in linking mutual fund plans to total returns index is that fund companies, while computing net asset value of some schemes, should take into consideration the valuation of securities the scheme holds as well as corporate actions such as dividends.

For instance: If an equity scheme claims to have returned 10 percent, versus 8 percent returns for the benchmark Nifty, the Nifty's return does not include the 1.5-2 percent dividend yield that the index may have clocked.

SEBI now wants to change the methodology to calculate NAV and bring them in line with global standards that are used to assess fund returns. 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, industry experts have a different argument on the proposal.

They say that while linking fund schemes to a total returns index formula may drive it from principles to a prescriptive approach, it may not be suitable for all market conditions.

In a total returns index, the assumption is that the returns figure 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 while a few only have 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 at all, even as a total return index assumes all stocks issue dividends.

If the 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 NSE and BSE will make a total returns index on Nifty and Sensex public and transparent on daily basis to enable the fund industry have a transparent benchmark.

In the 2012 reform of MF regulations, when realizable 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 back to prescription days again rather than the principle based days (Principle based regulation is high on the agenda of International Organisation of Securities Commission in developed markets).

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.
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