With SEBI raising bar for MFs, more underperformers may emerge

Benchmarking with total returns index will affect large-cap funds the most

SEBI’s move to mandate benchmarking mutual funds’ performance to the Total Returns Index (TRI) from February 1 rather than the price index could increase the number of underdogs in funds.

In 2017, almost half the 30 funds benchmarked to the BSE 100 index underperformed this index; two-thirds of the mid-cap funds benchmarked to the Nifty Midcap 100 index fared worse than this index; and 43 per cent of the funds benchmarked to the Nifty 500 index did not outdo this index.

This under-performance can worsen when the TRI is used. TRI increases the benchmark return as it takes the dividend payout of stocks also into account besides capital appreciation. Quantum Mutual Fund, DSPBR Mutual Fund and Edelweiss Mutual Fund are already using TRIs to measure performance.

A study of the returns from 2011 shows that TRIs have bettered the price indices by 1-2 percentage points every year since then. This outperformance remains when considering returns over 1-, 3- and 5-year periods, too.

Challenges ahead

Mandatory benchmarking to the TRI implies that active fund managers may have to work harder to outdo the benchmark. And that is easier said than done. For one, this changeover comes at a time when, as per SEBI’s direction, a process of categorisation and rationalisation of mutual fund schemes is in the works. Under this, SEBI has brought in a stricter definition of large- , mid- and small-cap stocks as well as funds. These changes are expected to affect large-cap funds the most. Consider this; six out of the 36 funds benchmarked to the Nifty 50 returned lower than the benchmark in the 2017 rally when considering the price index. But, compare it with the Nifty 50 TRI, the number of under-performers double to 12.

Higher expense ratios charged by diversified large-cap funds for their active management compared with the ETFs / index funds and narrowing return differential between these two categories are expected to give a leg-up to such passive funds.

On the other hand, while mid-cap funds did have a bad 2017, moving to TRIs may not affect them as much as large-caps, says Radhika Gupta, CEO, Edelweiss Mutual Fund. “If your fund size is reasonable, you are doing bottom up stock picking and betting on under-researched sectors and stories, beating a TRI benchmark will not be a problem for mid-cap funds in the next few years,” she explains.

However, Radhika adds that large-size mid-cap funds that have asset sizes of ₹10,000 crore or more may find the going difficult after these changes as they would restrict their universe.

Secondly, as TRI is a more stringent benchmark, fund houses will also have to take a re-look at whether their present benchmarks are apt.

Says Kunal Bajaj, Founder and CEO, Clearfunds.com: “SEBI’s January 2018 diktat on benchmarking to the TRI also requires mutual funds to select a benchmark that is in alignment with the investment objective, asset allocation pattern and investment strategy of the scheme.” Currently, inappropriate benchmarks for many funds drive up their outperformance.

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