What a total return index shows

By comparing returns against a total return index, DSP Blackrock wants to establish greater transparency and credibility

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DSP Blackrock Investment Managers Pvt Ltd recently announced its decision to also measure performance of its schemes against a total return index (TRI), rather than just a price index. The management team at DSP Blackrock feels that this is a better way of benchmarking the excess returns generated by the fund managers, and there was no reason not to include this format. Here is what you need to know about the total return index.

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What is it?
An index is a basket of securities taken at the prevalent market price. The change in value of this basket is the collective sum of the change in price of the securities in it.

Unlike a price index, a total return index considers both price changes and other payouts like dividends and interest to determine returns. Hence the term 'total return'. Given that a mutual fund scheme's return also includes both price changes and additional returns from payouts-like dividend-comparing this return to a total return index rather than just a price index is logical.

DSP Blackrock's announcement applies to its actively managed equity funds, for which performance will now be measured against the total return index.

Why the change?
By comparing returns against a total return index as well, the fund house wants to establish greater transparency and credibility in communicating performance to its investors. The return of a total return index for the same basket of securities is always going to be higher than the return of the price index, thanks to the additional payouts. Hence, only considering a price index overstates the degree of outperformance of a scheme against its benchmark. In the current market, where recent outperformance of equity mutual fund schemes is adding to inflows from retail investors, this change in performance measurement is more relevant.

Impact on investors
For investors, this means a more precise performance measure when you consider DSP Blackrock's schemes against the benchmark.

However, if you are choosing which fund to invest in based on a peer-group return comparison over a predetermined period, this will not matter in making the selection. Nevertheless, a more comprehensive total return benchmark gives a truer picture for investors.

Impact on managers
Many times, fund managers have internal targets of consistently outperforming the scheme's benchmark by a predetermined level of performance. For example, the internal target may be outperforming the scheme's benchmark by at least 3% per annum. Now, if the total return index has delivered, say 1% higher than the price index, the fund manager will have to generate that additional 1% excess return to be able to meet her target.

This, in a way, pushes fund managers to try harder and not rely on technical discrepancies for making the alpha or excess return look good, which is a positive outcome for investors.

It remains to be seen whether such a shift leads DSP Blackrock's fund managers to pay more attention to high-dividend paying stocks or if it increases the holding period for stocks that are consistent dividend payers. These aspects may be more intrinsic to a fund manager's style rather than dictated by the benchmark. But in times when market return gets hard to beat, it is not unimaginable.

Total return index brings better clarity and accuracy to return comparisons, which investors should welcome.

In arrangement with HT Syndication | MINT

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