Explainer |Total return index: How does it impact you as a mutual fund investor

It has been little over a year since the capital market regulator, Securities and Exchange Board of India (SEBI) mandated (effective February 1, 2018 to be precise) that all mutual fund houses should compare their schemes against total return indices (TRI).

Let's look at how that has changed your life as a mutual fund investor.

Every mutual fund is mandated to compare its performance against its chosen benchmark index. That has been happening for years. But a TRI version of an index is closer to its underlying companies’ performance than the price return index (the version of indices we usually see in public).

Why?

It includes price movements, dividends and other payouts. The dividends and other payouts may not be the focus are of most investors who deal in stocks. However, they can amplify your returns in long term. Over the past five years, CNX Nifty index gave 11.5% compounded returns, but Nifty TRI gave 12.92% compounded returns.

An index is a basket of securities. Each security has a market price. Each of the constituent securities is given a weight and the price is taken into account accordingly. That gives the value of the index at a given moment of time. The prices of individual securities change and hence the value of the index also changes.

When we hear Nifty closing at, say, 11,500 from say, 11400 at the time of opening, we refer to the price performance of the index. In the industry it is known as price index.

But the real world is different. The price index may be useful to track short term moves in the market – say over a few minutes or a day or a week. But in the long term, the constituent companies do announce dividends and other cash payouts.

When an investor or a mutual fund scheme invests in a stock, it must account for such receipts. The scheme’s NAV reflects these receipts, but the price index does not. That is why a more holistic benchmark index- the TRI- is called for.

Quantum Mutual Fund was the first mutual fund to use Sensex TRI as the benchmark for its flagship scheme - Quantum Long Term Equity Value Fund (earlier known as Quantum Long Term Equity Fund), followed by DSP Mutual Fund.

Use of TRI will ensure a higher threshold for the fund managers to beat. This will be a game changer in the large cap focussed mutual fund schemes where the extent of outperformance is less compared to mid-cap funds. As per SPIVA India Scorecard, on June 31, 2018, 88% of large cap equity funds underperformed the S&P BSE 100 over past one year.

Over three and five year period these numbers stood at 78% and 63%. Going forward, well-researched space of large cap stocks will see deterioration in outperformance.