All mutual fund investors that I know of-and I really do mean all-use nothing but funds' returns to compare and choose between funds. There may be some professional investors who take a more sophisticated view and use other measures, but they would be in a tiny minority. The most popular number on which to compare funds is the one-year return but a few investors also use returns for longer or shorter periods.
Actually, there are other types of numbers that are more useful, in the sense that they can add to the usefulness of evaluating funds' returns. Apart from a small number of investors who use independent websites and publications to make returns comparisons between funds, most investors depend on information published by the fund companies or fund distributors. This information is often incomplete, non-standardised and therefore not comparable. Now, as part of its intense effort to re-engineer the mutual fund industry, SEBI has proposed a comprehensive framework of calculating and publishing mutual fund performance statistics. The thrust of this new framework is along two axes. One, emphasising some other parameters apart from only returns. And two, complete standardisation of the not just the way these returns are calculated but how and where all they are publicised.
The part about calculating returns has new elements added to it. One, all funds will have to have comparative returns vis-à-vis two benchmark indices. One would be whatever index the fund house has otherwise chosen, and the second would a standard benchmark that can be either the S&P CNX Nifty or the BSE Sensex. Moreover, fund houses would also have to calculate not just the returns vis-à-vis these benchmark indices but also a range of risk and volatility measures that can inform an investor not just what returns the fund generated, but also how much risk it took in doing so and how volatile it was for different periods. The proposed norms also lay down the precise treatment of dividends in the calculation of returns. For debt and balanced funds, the standard benchmarks are different but the general idea is the same.
Apart from calculating in a standard manner, SEBI has also proposed standardisation of the way returns are published. Currently, funds manage to pick and choose what periods they reveal returns over. Under the new system, the fact sheets published by funds as well in advertisements, brochures and other marketing material, funds will have to publish performance data in a standardised and comprehensive manner. If a fund doesn't have good returns in a particular period, then there will be no chance of hiding that.
Broadly speaking, I believe that the new norms will bring a desirable standard of transparency to fund performance. The obvious criticism of the proposed norms is that (one that is being voiced privately by some fund houses) is that they are too complex for investors to understand. I don't agree with this. It is true that investors will have to work harder to absorb and interpret the data and many investors will not be capable of doing that. However, that can't be a justification for continuing with the current trend of choosing convenient benchmarks and cherry-picking favourable returns numbers.
In anything to do with investments and finance, more data and more transparency is always better, without exception. Even if only a handful of investors and analysts use the information, having to reveal it the world at large is a useful check.
This article was originally published on June 09, 2010.
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