Come February 1, managers of active mutual funds in India may have to strive a little harder to impress their investors. The Securities and Exchange Board of India (SEBI) has decreed that all MF schemes must adopt the Total Return variants of their chosen benchmarks to measure and disclose their performance. As the vast majority of equity funds have been showcasing hefty alphas (excess returns over the market) through the simple expedient of ignoring dividend receipts, and measuring themselves against price gains alone, this diktat is welcome. In fact, it is not very heartening that the fund industry, which features quite a few global giants, needed a nudge from the regulator to fall in line with this established global practice.
It is not altogether surprising that domestic fund houses have preferred to stick with price-based indices for over two decades of their existence. Though India is not a high dividend yield market, ten-year returns on the Total Return variants of the Sensex30 and Nifty50 are 150-160 basis points higher than their simple price variants, which would have raised the bar on fund performance. Benchmarking to Total Returns will now mean that active managers will have to perforce generate their ‘alpha’ from superior stock selection or allocation decisions, rather than simply pocketing dividends. In fact, by reducing the artificially high alpha that active schemes are able to showcase, Total Returns benchmarking may also have the desirable side-effect of tempering the climbing expense ratios of domestic funds. Recently, SEBI has been pointing out that expense ratios of 2.5-3.3 per cent for domestic equity funds are rather high by global standards.
But even these changes will not entirely solve benchmarking problems for fund investors. One, while the price indices of both the exchanges are in the public domain, Total Return indices at a daily frequency are available only from the NSE. For investors to be able to independently research fund performance, Total Return indices from both BSE and NSE will need to be freely accessible for time periods of the investors’ choice. Two, while these interventions usher more transparency into equity scheme benchmarking, the benchmarking of debt and hybrid products remains a complete black box, with fund houses using proprietory or self-constructed indices which are completely inaccessible to lay investors. The logical next step for SEBI is to encourage independent global index providers to expand their product offerings in India, so that the exchanges too have some competition on innovating on their benchmarks.