Sebi wants MFs to adopt tougher benchmarks

The Securities and Exchange Board of India (Sebi) is evaluating the category of benchmarks being currently used to compare the returns of mutual fund (MF) schemes. 

The net asset value (NAV) of MF schemes takes into account dividends for computing returns. The schemes are, however, benchmarked against “price return” indices that do not take into consideration the dividend component. 

On an average, the dividend yield for Indian equities works out to 1.25-2 per cent for a year. In other words, dividend yields can add anywhere between 1.25 per cent and two per cent to the returns of MF schemes. 

“The NAV of schemes takes into consideration the valuation of the security as well as the dividend. So the NAV that comes out is a ‘total return’ NAV. The benchmark indices that are available are all ‘price’ indices. We need to move in a direction where there is a like-to-like comparison,” said a Sebi official.

Total return benchmark indices assume that any cash distribution, such as dividend, is reinvested into the index. Comparing MF scheme returns with these indices, therefore, makes it a more equitable comparison. Globally, except derivative products, 90 per cent of MF schemes are benchmarked to total return indices, according to experts. 

“The sector should gradually move to total return indices for comparing scheme performance as it will give a more accurate picture of the fund managers’ capability and bring in more transparency,” said Manoj Nagpal, chief executive officer, Outlook Asia Capital. “The returns will remain the same, but the alpha will reduce to the extent of the dividend.”

According to Ravinath Dasika, co-founder at Tavaga, a robo-advisory firm, a lot of funds that are just about beating the indices by one-two per cent may suddenly fall behind the benchmark if the comparison shifts to total return indices. 

“About 70 per cent of large-cap schemes, for instance, are believed to have outperformed their benchmarks in their three-year rolling returns over a 10-year period. This figure may decline to about 25 per cent. So, over time fund managers will have to get to a lot more efficient,” Dasika said. 

The impact will be more pronounced on large-cap rather than mid-cap schemes. As of March 17, large-cap schemes outperformed their respective benchmarks by 2.25 per cent and 1.48 per cent over a three-year and five-year period, respectively, data collated from Value Research show. After subtracting the 1.5 per cent dividend yield, the outperformance is reduced to 0.75 per cent for a three-year period and is wiped out completely for a five-year period. 

Mid-cap schemes outperformed their respective benchmarks by 4.6 per cent and 5.6 per cent over a three-year and five-year period, respectively. 

Their outperformance, after subtracting the 1.5 per cent dividend yield, is reduced to 3.1 per cent for a three-year period and 4.1 per cent for a five-year period.

BREAKING IT ALL DOWN

What’s the fuss all about? 

Net asset value (NAV) of MF schemes takes into account dividends for computing returns. The schemes are, however, benchmarked against indices that do not take into consideration the dividend component

And what’s NAV? 

In relation to mutual funds, NAV is the market value of a fund share. This is normally given as the bid price, which is the price at which investors in the fund can cash out their shares. The NAV 

is calculated by subtracting any liabilities the fund might have from its total assets (whose value is usually updated daily after the close of trade), then dividing by the number of outstanding shares so that the NAV is expressed on a per-share basis

So how do we make better comparisons? 
 

Total return benchmark indices assume that any cash distribution, such as dividend, is reinvested into the index. Comparing MF scheme returns with these indices, therefore, makes it a more equitable comparison. Globally, except derivative products, 90 per cent of MF schemes are benchmarked to total return indices, according to experts 

Impact in case of like-to-like comparisons  

The impact will be more pronounced on large-cap rather than mid-cap schemes. As of March 17, large-cap schemes outperformed their respective benchmarks by 2.25 per cent and 1.48 per cent over a three-year and five-year period, respectively, data collated from Value Research show. After subtracting the 1.5 per cent dividend yield, the outperformance is reduced to 0.75 per cent for a three-year period and is wiped out completely for a five-year period.