A comparison between PRI (Price Return Index) and TRI (Total Return Index) in the last five years shows total returns of the S&P BSE 100 is 165 basis points higher every year.
Your investments in largecap funds will increasingly face the risk of under-performing the index they are benchmarked against. A study by Morningstar showed the number of large-cap funds beating their benchmark dropped from 85 per cent to 58 per cent once the benchmark's performance is calculated on the basis of the Total Return Index (TRI).
A Total Return Index includes dividends and other gains in addition to the stock price movements, boosting the value of benchmark indices like the Sensex and the Nifty. This results in the gap between the scheme and bench-mark index returns shrinking.Currently, most domestic mutual funds benchmark their schemes to simple price index, which considers only the price movements of stocks that make up the index.
Three asset managers Quantum Mutual Fund, DSP Blackrock Mutual Fund and Edelweiss Mutual Fund have shifted benchmarking their scheme performance to indices based on Total Return Index. Many more fund houses are expected to follow suit with Sebi nudging the industry to adopt this method.
"Benchmarking against the TRI represents the true alpha being generated through active management," says Kaustubh Belapurkar, director (fund re-search), Morningstar India.
A comparison between PRI (Price Return Index) and TRI (Total Return Index) in the last five years shows total returns of the S&P BSE 100 is 165 basis points higher every year.
The shift is likely to impact the outperformance of the large-cap schemes the most, said analysts.
"Large-cap funds have never been big outperformance of their index, as it is difficult for them to go heavily overweight or underweight a sector or stock. If one uses Total Return Index, their outperformance will come down by 1-1.4 percentage points. Investors looking for higher outperformance would have to go with diversified (multi-cap) funds," said Vidya Bala, head (research) at fundsindia.com.
Given that large-cap funds charge anywhere between 1.5 per cent and 2.5 per cent for their regular plans, many analysts believe the expense ratio of these funds would have to come down for them to be competitive. If the outperformance is not high, investors could also move towards ETFs or index funds, which have lower expense ratios. However, there is not much choice in the ETF space, with the ones there being illiquid or traded on just a few indices.
"There is scope in our market to build better indices on which one can build smart beta ETFs or index funds which can generate optimal return with a tight cost structure. Large cap funds could also run with quant based models with some active management.These structural changes in the largecap space is already being explored by some fund houses," said Bala.
