In 2018, the Securities and Exchange Board of India (SEBI) had mandated mutual fund houses to adjust the measurement of fund performance. From February 1, 2018, fund houses were instructed to use the Total Return Index (TRI) as their new benchmark. The goal of such a move was to provide a proper benchmark to the investors. Before they invest, investors can now use the Total Return Index (TRI) to get an accurate view of any mutual fund scheme.
All mutual fund schemes were previously benchmarked against the Price Return Index (PRI). This index determined was inadequate in capturing a mutual fund scheme’s overall performance.
What is a benchmark?
A benchmark, often known as an index, is a group of assets purchased at the current market price. The benchmark’s value is equal to the sum of its components’ prices. When the price of its constituents varies, so does the price of the benchmark. The benchmark serves as a yardstick against which a mutual fund’s performance can be measured. If the fund underperforms the benchmark, it is said to have underperformed against the index and vice versa.
Total Return Index vs Price Return Index
An investment in a mutual fund earns returns through two methods – capital appreciation and dividend disbursements. The increase or decrease in the market price of a security is referred to as capital appreciation. Both the components are important when calculating the returns provided by a security.
Until recently, however, only one of these was taken into account when evaluating performance. Only the capital appreciation component of index constituents was captured by the Price Return Index (PRI), which served as a benchmark for mutual fund schemes. It neglected the fact that mutual fund plans pay out dividends. To make things more transparent and credible, the Total Return Index (TRI) was introduced.
To calculate returns, TRI takes into account both capital gains and dividends. Total Return Index will always be greater than Price Return Index for the same basket of assets because of dividend payouts. As a result, focusing solely on PRI may exaggerate how far the mutual fund scheme exceeded the benchmark. In a nutshell –
|Total Return Index
|Price Return Index
|TRI takes into account capital appreciation and dividend payouts when calculating returns.
|PRI takes into account only capital appreciation and ignores dividend payouts.
How do PRI and TRI impact you as an investor?
Using Total Return Index instead of Price Return Index can have an impact on your future investment plans, especially when it comes to transitioning from active to passive investing. It is thus advisable for you to monitor your portfolio regularly and compare the performance of funds by using appropriate indices.
You can also reach out to a financial advisor for guidance on how to reach your required quantum of mutual funds in short term and long term to fulfill your financial goals.