On January 04, 2018, SEBI issued a circular directing mutual fund schemes to benchmark the scheme’s performance to Total Return variant of an Index (TRI), instead of the currently used Price Return variant of an Index (PRI) from February 01, 2018 (“Circular”).

Mutual funds are required to disclose the benchmark indices in scheme related documents. Benchmark indices are generally market indices such as BSE Sensex, CNX Nifty, etc., which are chosen based on the objectives of the scheme, and whose performance is compared with the performance of the scheme. At present, most of the equity mutual funds are benchmarked to the PRI of an index. PRI only represents a change in the market value of the constituents of an index, and does not include dividends and interest payments generated by such constituents. Therefore, PRI does not represent an accurate picture of the performance of the benchmark index.

With the objective of enabling investors to compare performance of a scheme with an appropriate benchmark, the Circular directs mutual fund schemes to disclose performance based on TRI. TRI takes into account the value of dividends and interest payments, in addition to the change in the market value. If TRI is not available for a particular period, mutual funds are directed to calculate composite return of the index using PRI benchmark until TRI is available, and subsequently use the TRI benchmark.

Even though certain AMCs like Quantum AMC had been using TRI benchmark for more than a decade, many mutual funds use PRI as TRI figures were not available in the public domain for many indices. Further, as mutual funds hold certain amounts in cash which hinders their performance, the funds probably prefer the PRI benchmark to offset the impact of reduced returns. However, such a comparison between the PRI benchmark and the fund’s performance would present an erroneous rosy picture to the investors.

The dividends and interest generated by the constituents of an index are reinvested by many mutual funds, thus generating higher returns. Therefore, comparing these returns to only the price variation of the index, as captured by the PRI benchmark, is not accurate. The change in the benchmark to TRI would lead to greater transparency and better comparison of the mutual fund schemes for investors. But, the TRI variant benchmark would invariably be higher than the PRI variant benchmark, leading to a shrinkage in performance of the schemes vis-à-vis their benchmark indices. Mutual funds charge a fee from investors for managing their funds, while exchange traded funds (ETFs) with similar benchmark indices are relatively cheaper. Therefore, in case of only a marginal difference between the performance of the schemes vis-à-vis their TRI benchmark indices, there is a possibility of investors shifting from mutual fund schemes to the cheaper ETFs. However, as trading in ETFs is a more hands-on approach in comparison to investing in mutual funds, a directly correlated exodus of investors from mutual funds to ETFs in such a case may not occur.

This move to TRI variant, while necessary from an investor point of view, is bound to pressurize the fund managers to substantially increase the returns in a bid to outperform the benchmark.