Come February 1, managers of active mutual funds in India may have to strive a little harder to impress their investors. The Securities and Exchange Board of India (SEBI) has decreed that all MF schemes must adopt the Total Return variants of their chosen benchmarks to measure and disclose their performance. As the vast majority of equity funds have been showcasing hefty alphas (excess returns over the market) through the simple expedient of ignoring dividend receipts, and measuring themselves against price gains alone, this diktat is welcome. In fact, it is not very heartening that the fund industry, which features quite a few global giants, needed a nudge from the regulator to fall in line with this established global practice.
It is not altogether surprising that domestic fund houses have preferred to stick with price-based indices for over two decades of their existence. Though India is not a high dividend yield market, ten-year returns on the Total Return variants of the Sensex30 and Nifty50 are 150-160 basis points higher than their simple price variants, which would have raised the bar on fund performance. Benchmarking to Total Returns will now mean that active managers will have to perforce generate their ‘alpha’ from superior stock selection or allocation decisions, rather than simply pocketing dividends. In fact, by reducing the artificially high alpha that active schemes are able to showcase, Total Returns benchmarking may also have the desirable side-effect of tempering the climbing expense ratios of domestic funds. Recently, SEBI has been pointing out that expense ratios of 2.5-3.3 per cent for domestic equity funds are rather high by global standards.
