October 04, 2017

Total Return Index Benchmarking

Around six weeks ago, DSP BlackRock MF stated its intention to “compare its funds’ performance” to the total return of their respective benchmark indices.  A few days later, Edelweiss MF made a similar announcement.  While these were noteworthy decisions, I couldn’t quite understand the need for these fund houses to formally proclaim their intentions to the world at large.  To be honest, a part of me felt that these announcements had a holier-than-thou ring about them.  More than that, though, it was the wide media coverage of these announcements that stood out for me.  Sure, it was helpful in spreading awareness about the difference between a Total Return Index (TRI) and a Price Return Index (PRI).  But beyond that, it seemed to me that most of the coverage was hype and lacked clear perspective.  In this post, I’d like to chip in with some scattered thoughts.

TRI benchmarking has little to do with appropriateness
By any reasonable standard, the appropriateness of a scheme’s benchmark index is determined by the similarity of the constituents of the benchmark with the universe of securities that the scheme will invest into.  So, for a scheme that invests in large cap stocks, the Nifty 50 or the BSE Sensex could both be appropriate benchmarks.  It is a fund house’s individual decision as to which index to choose as the formal benchmark.  As for choosing a TRI over a PRI, that has little to do with appropriateness in that sense: it is more like raising the height of a hurdle to jump over. If a fund house chooses a TRI over a PRI, then at best it can be assumed to be signalling its intent to raise the bar for its performance.  Bear in mind, though, that a fund house can raise the bar for its performance in any number of ways, and without making such announcements. 

Where will performance be reported?
Even if a fund house chooses TRI benchmarking, its performance reporting will be restricted to documents that are released by it (e.g. fact sheets, SID, KIM etc.).  So, to investors who prefer to compare scheme performances across multiple fund houses, such reporting will be of little use. 

Investors can choose their own benchmark
No matter what benchmark index a fund house chooses, in analyzing the performance of a scheme, an investor is always free to use whatever benchmark index he or she thinks appropriate.  For example, in all instances of index data used by me on both my blogs, I have used total return numbers only.  It is not as if that is necessarily better than using price return numbers: it is merely an expression of my personal belief.  And I have done so, regardless of what practice the industry or individual fund houses have followed.

The notion of “alpha” varies
There are some who argue that a TRI is a better choice for accurately determining “alpha”.  In my opinion, a lot depends upon how one defines “alpha”.  For those who regard “alpha” as a mathematical formula, it is understandable for them to prefer a TRI over a PRI.  But in my experience, for most people who look for “alpha”, it is just a broad appraisement of the value added by a fund manager.  Sure enough, some of these people assess “alpha” against a TRI but there are many to whom the TRI/ PRI choice may be inconsequential.  There are also those who believe in assessing “alpha” against an appropriate index fund (rather than an index) while there are yet others who, in their own wisdom, assess “alpha” against the returns from a bank deposit.

TRI benchmarking is not new in India
In conversations with investors and advisors, I gathered that quite a few of them were under the impression that these announcements were pioneering/ ground-breaking in the context of the Indian fund industry.  In fact, there was at least one report, in The Economic Times, which credited DSPBR MF as “the first fund house to start with this practice”.  The truth is that Quantum MF has been following TRI benchmarking for years, for both its equity schemes, as well for its Nifty ETF.  Other fund houses following this practice selectively include IDBI MF and Kotak MF (thanks to one scheme taken over from the erstwhile Pinebridge MF).  And then there are some fund houses that have taken a somewhat convoluted approach, if I may call it that.  To take an example, SBI MF compares the returns of its Nifty Index Fund with the Nifty 50 PRI, but measures its tracking error against the Nifty 50 TRI.  As far as I am aware, none of these fund houses trumpeted their decisions and perhaps, for that reason, these haven’t attracted the media coverage that the more recent announcements have.

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