SEBI’s New Rule: Highlighting Risk-Adjusted Returns for Mutual Funds – Benefits and Challenges

The Securities and Exchange Board of India (SEBI) has proposed a mandate for the disclosure of Risk-Adjusted Returns (RAR) for all mutual fund schemes. This consultation paper aims to gather feedback from stakeholders on the potential benefits and challenges associated with this mandate.

Importance of Return on Investment

Currently, the return on investment is a primary factor attracting investors to mutual fund schemes, heavily emphasized in their marketing efforts. So, in that case if two funds might yield the same return over a year, but a fund with higher volatility implies greater risk for investors. As a result, there is a need for RAR. 

Understanding Risk-Adjusted Return (RAR)

The RAR of a scheme portfolio offers a holistic measure of a mutual fund’s performance by quantifying the return generated for each unit of risk taken. According to SEBI’s consultation paper, this metric provides a more comprehensive evaluation of a scheme’s effectiveness. Investors are encouraged to send in their comments by July 19.

Current Challenges in RAR Disclosure

While some Asset Management Companies (AMCs) already display RAR for certain schemes, there is no uniform method for its calculation. Additionally, inconsistencies exist in the frequency of disclosure and the NAVs used for these calculations. Knowing the RAR can enable investors to make more informed decisions, potentially increasing confidence and loyalty towards the mutual fund industry.

Potential Complications for Retail Investors

Despite the benefits of higher disclosure, the variety of equity, hybrid, and debt schemes can make understanding RAR challenging for retail investors. SEBI’s directive will mandate mutual funds to disclose the Information Ratio of a scheme portfolio alongside the return of its respective benchmark, detailing the measures used to arrive at the RAR.

 Balancing Transparency and Complexity

While increased transparency is beneficial, the complexity of these measures can pose challenges for average investors, potentially leading to misinterpretation and impacting investor confidence and market dynamics. The concept of publishing RAR is not new, as most advisors already consider it when making investment decisions. However, implementing this uniformly could standardize risk-adjustment metrics, allowing for effective comparisons across schemes and empowering market participants to make informed decisions.

A Step Towards Better Evaluation

RAR is essential for properly evaluating a portfolio or fund manager, and progress in this direction is welcome. In India, alpha is often referred to as the difference between the return of the fund and the benchmark, whereas in the US, alpha typically implies RAR.

Transparency and informed decision-making are crucial for the mutual fund industry. SEBI’s initiative for RAR disclosure is intended to enhance these aspects by providing investors with a clearer understanding of the risks and returns associated with different mutual fund schemes.

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Disclaimer: This blog has been written exclusively for educational purposes. The securities mentioned are only examples and not recommendations. The information is based on various secondary sources on the internet and is subject to change. Please consult with a financial expert before making investment decisions