SEBI's new proposal: What mandatory risk-adjusted return disclosure means for mutual fund investors
The Securities and Exchange Board of India (SEBI) has introduced a consultation paper proposing mandatory disclosure of risk-adjusted returns by mutual funds.
This is meant to provide a clearer picture of mutual fund performance by emphasising not just returns, but the risks taken to achieve those returns.
Understanding risk-adjusted return
The concept of Risk-Adjusted Return (RAR) offers a more comprehensive evaluation of a mutual fund’s performance.
Unlike simple return metrics, RAR accounts for the level of risk undertaken to achieve those returns.
SEBI’s consultation paper articulates that RAR quantifies the return generated per unit of risk.
Current disclosure practices
SEBI’s observations revealed inconsistency in the disclosure of RAR among fund houses.
While some fund houses voluntarily disclose RAR, the methods of calculation vary, leading to potential confusion among investors.
For instance, only 33 out of 39 fund houses with equity schemes disclose RAR, and among those with hybrid schemes, merely 27 out of 36 do so.
Proposed standardisation
To address these inconsistencies, SEBI proposes the mandatory disclosure of RAR using the Information Ratio (IR) as the standardised metric.
The IR is calculated as the ratio of Tracking Difference (TD) to Tracking Error (TE) over a given period.
Essentially, IR measures the excess return of a portfolio relative to its benchmark, adjusted for the volatility of that return.
A higher IR indicates a better risk-adjusted performance.
Implications for investors
The implementation of standardised RAR disclosure is poised to benefit mutual fund investors significantly:
Enhanced transparency: Investors will gain a clearer understanding of how much return a fund generates for each unit of risk taken.
This will facilitate more informed investment decisions.
Better comparison: Standardised RAR metrics will allow investors to compare different mutual fund schemes more effectively.
Improved confidence: Clearer risk-return metrics can boost investor confidence.
This can lead to greater participation in mutual funds.
Next steps
SEBI’s proposal is currently open for public comments until July 19, 2024.
If implemented, mutual funds will be required to publish their IRs on all publicly accessible platforms, including their websites and the Association of Mutual Funds of India (AMFI) website.
Schemes less than six months old will be exempt from this requirement.