Benchmark and TRI

1. Introduction

Recently, SEBI asked mutual fund houses to change the manner which they were benchmarking the fund performance (As per Circular ‘Benchmarking of Scheme’s performance to Total Return Index’ dated Jan 04, 2018). They were instructed to consider Total Return Index (TRI) as the new benchmark and everyone has already complied. Earlier they were using Price Return Index (PRI).

2. TRI vs PRI Index

An investment vehicle like shares generates returns by two means i.e. capital appreciation and dividend payouts. Capital appreciation relates to the increase or decrease in the market price of the share. While measuring returns which a share actually generated, both of the above components play crucial role.

However, until recently, only one of them was considered for gauging performance. The Price Return Index (PRI) captured only the capital appreciation aspect of index constituents. It ignored the dividend payment component of the constituent shares. Example, if suppose SBI Bluechip Fund has a benchmark of BSE 100, then returns of BSE 100 index are calculated only through the capital appreciation of its constituent companies. Whatever dividends those companies paid was completely ignored. However, this dividend component is obviously not ignored in calculating SBI Bluechip fund’s performance.

Typically, the dividend in an index is around 1.5 per cent annually. Since the previous indices are exclusive of the dividends, it understates the returns of the indices by about 1.5 per cent annually. To make things transparent and credible, Total Return Index (TRI) has been introduced. This index includes both the capital gains and dividend component to determine returns.

So BSE 100’s TRI index will be called as BSE 200 TRI and from now on, SBI Bluechip fund will be benchmarked against this BSE 100 TRI.

For an identical basket of securities, the return of a total return index will always be greater than that of the price return index. It will be due to the additional payouts by way of dividends. With TRI coming in, the returns of the index will go up by 1-1.5 per cent yearly by default. Let us say that there was a particular scheme that claimed to beat the benchmark by 2.5 per cent in a year. That outperformance will now come down to one per cent.

3. What is Mutual Fund Benchmarking?

Benchmark means a standard against which the performance of the fund can be measured. The selection of benchmark depends upon the investment objective and asset allocation of the fund.

If a fund is giving higher return than its benchmark or falls with a lesser amount than the benchmark we can say that the mutual fund scheme is consistently outperforming.

If the fund is giving a similar return or less return as compared to the benchmark, we can say the mutual fund is underperforming. This comparison plays a very important role for the investors making investment decisions.

Benchmark is the reference point with which Mutual Fund scheme’s performance is compared. Since 2012, SEBI made it mandatory for fund houses to declare a benchmark index for each of their schemes. Benchmark is something your fund mostly correlates to. These benchmarks are usually a well-established index of securities. It is mandatory for fund houses to show scheme performance against the benchmark while marketing a scheme.

Example- For a large cap fund, benchmark would be mostly Nifty 100 or BSE 100, because these indices are the indicators of the large cap companies. And the whole point of investing in a large cap mutual fund is that it should give you better returns than these indices, otherwise you can always invest directly in these indices (through index funds) and get the same returns with much lesser fees. Similarly, a Conservative Hybrid Funds would have the NIFTY 50 Hybrid Composite Debt 15:85 index as its benchmark.

Benchmarks are useful for two purposes:

1. First, benchmark helps giving the reference point for comparing fund’s returns. By comparing with benchmark, you will know your scheme is performing well or not. If it is consistently performing below benchmark, then it is definitely time to switch out.
2. Secondly, benchmark also gives you a fair idea of the type of portfolio Fund’s scheme will have. For example, there could be a large cap fund which has a benchmark BSE 100 (Top 100 companies) and there could be other which has a benchmark BSE Sensex (Top 30 companies), now with the kind of benchmark you would get a fair idea of where the fund will invest its money.

HDFC Mid cap opportunities fund compared with Benchmark -nifty free float midcap 100

In the above case the fund has performed well than benchmark in return, Std deviation, alpha, Sharp ratio parameters, but this performance should be consistent.

Reason why we are taking the benchmark as nifty free float midcap 100 and not nifty or sensex-

Because nifty is made of 50 stocks and sensex is made of 30 stocks and equity mutual fund on an average holds 80 stocks and so comparing the 80 stocks with 50/30 stocks would not be correct. Hence we need a border index, and so various indices exits which suits various category of fund.