The capital market regulator, Securities and Exchange Board of India (SEBI) has floated a consultation paper proposing that mutual funds should disclose risk-adjusted return, in addition to return.
In its consultation paper, SEBI has said that “the “Risk Adjusted Return” (RAR) of a scheme portfolio represents a more holistic measure of the scheme’s performance because it quantifies the amount of return generated by a MF scheme for each unit of risk taken to achieve that return.”
SEBI observed that quite although quite a few fund houses disclose RAR, the method to compute differs from fund houses to fund house. Also, it observed that not all fund houses disclose RAR figures. For instance, it observed that of the 39 fund houses that have equity schemes, only 33 disclose RAR. Of the 36 fund houses that have hybrid schemes, just 27 disclose their risk-adjusted return numbers.
The regulator has now proposed to make it mandatory. Further to enhance transparency and standardization, the consultation paper has nominated the Information Ratio (IR), to be the standardised risk-adjusted ratio that needs to be published. The IR is the ratio of Tracking Difference (TD) to Tracking Error (TE) of a scheme portfolio over a given period of time. While the TD is the excess return of the portfolio with regards to its benchmark, the TE refers to the volatility or standard deviation of the excess return. Therefore, the IR tells you how much excess return the fund has generated, for every unit of risk it has taken.
The higher the IR, the better is the fund’s RAR.
The disclosure of IR might be mandated in all publicly-available spaces (a mutual fund’s website, Scheme Information Document, and so on) as well as on the website of the Association of Mutual Funds of India (AMFI). SEBI has proposed that schemes that are less than six months old, needn’t publish their IRs.
The proposal is an additional disclosure and underlines SEBI’s concern of highlighting the risk level, and not just the returns that an investment earns.
Public comments are invited latest by July 19, 2024.
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