SEBI’s consultation paper on disclosure of Risk Adjusted Return by Mutual funds

I personally really like the fact that SEBI is giving a chance to investors and other market participants in the regulatory process, making it more democratic, by inviting comments on its consultation papers. I think people who are in this industry and who understand it to some extent should really make use of this opportunity. SEBI had released another consultation paper on “Introduction of Mutual Funds Lite Regulations (MF LITE) for passively managed Mutual Funds Schemes”. An article was published on freefincal by SEBI Registered Investment advisor S.R.Srinivasan. I think the consultation paper on Risk Adjusted Return is also worth looking at by retail investors, just to remind themselves that they have to be mindful of the risk associated with an investment option and compare it with their risk appetite.

In this article, I would like to briefly explain the proposals put down by SEBI.

The highlights of the CP are:

–          Defines a metric for risk adjusted return called as Information Ratio

–          Mandates AMCs to disclose this number on a daily basis

–          Gives a standardized format for this disclosure to make the data easily comparable between funds

1.       Mandatory Disclosure of Information Ratio (IR)

Mutual Fund schemes should disclose the Information Ratio (IR) alongside the scheme’s returns. The IR, which is one of the metrics of risk adjusted return, is calculated as the ratio of Tracking Difference (TD) to Tracking Error (TE). TD is the excess return generated by a fund w.r.t its benchmark and TR refers to the volatility/standard deviation of the excess return. Thus the IR as defined above represents the excess return relative to the benchmark per unit of risk.

2. Uniform Methodology for Calculating IR

The methodology for calculating IR should be standardized. For equity, hybrid, solution-oriented, and fund of funds schemes, the IR is calculated using the formula:

(Portfolio Rate of Returns – Benchmark Rate of Returns) / Standard Deviation of Excess Return

For debt-oriented schemes, the benchmark may vary depending on the category.

3. Daily Disclosure of IR and Exemption for New Schemes

IR should be calculated and disclosed daily on the websites of respective AMCs and the Association of Mutual Funds in India (AMFI), along with being included in all scheme-related documents.

For schemes in existence for less than six months, disclosure of past performance and IR is not mandatory. For schemes existing for more than six months but less than a year, IR based on annualized returns for the past six months may be disclosed.

4.       Standardized Disclosure Format

AMFI, in consultation with SEBI, should develop a standardized format for disclosing IR in various documents, ensuring consistency across the industry. You can refer to the format in the consultation paper here.

Your feedback can be submitted through the following link: SEBI | Public Comments

The intention of the regulator is very clear. It wants investors to consider risk adjusted returns while choosing funds and not go chasing returns. Even though the intention is good, the outcome may not be as expected. For investors to take a decision based on risk adjusted return, they would need the metric available for a number of funds at a single place, or the metric at various points of time for a specific fund to look at the trend. The former would help investors decide which fund is currently at a better position in terms of risk adjusted return. The latter would help them understand if a particular fund is consistent or not in terms of risk adjusted return.

Risk adjusted return for a number of funds together is already available on some aggregator websites where one can get the data free of cost. I haven’t yet come across data for a single fund at various time points, but then again, I might be wrong. Disclosing the information ratio on a daily basis might help the data driven investors in getting the trend of information ratio for a particular fund. The usual caveat still remains, you might be knowing it by heart now – past performance is not indicative of future.

The good part is that seeing the disclosure frequently might just induce a cultural change in investors, where they start giving more attention to the IR along with returns. Even if not that, it might help bring an awareness among investors who are just after returns. This might be a step towards improving financial literacy. The riskometer helped to a certain extent to know which funds were taking more risk that benchmark in case of debt funds, but it did not have the same impact in equity funds because the riskometer does not capture the nuances of risk in equity funds. IR disclosure might be a step in arming an investor with more data to help make his/her choice.

It is possible that the industry opposes these citing reason of lower value generated compared to the cost of disclosure (revamping documents to accommodate the format of disclosure and incorporating calculation of the IR in their regular process). This makes it more important for you to voice your requirements as an investor to the regulator.

For those of you who wish to provide feedback to SEBI on these proposals – the steps to provide comments are mentioned in the paper itself on page 7.

For each proposal, you have these options:

–          Skip to comment on the proposal (or)

–          Choose to give your level of agreement – from Strongly agree or Strongly disagree

–          Optionally choose to provide descriptive comments and rationale

You have to make these choices for all the proposals before you can submit.

Summary:

Being a fairly newcomer in the investment field, I cannot say whether these proposals, if brought into effect, will have any significant impact in investor behaviour or not. However, if you like more transparency from your AMCs, and you feel that such a data will help you in decision making, I urge you to provide your comments to SEBI. As I said earlier, it is an opportunity to be a part of regulation-making, a voting right that you have. As we say in elections, every vote counts. Your comments can be given here – SEBI | Public Comments Once again, the deadline for giving your comments is 19 July 2024.