SEBI Mandates AMCs to Disclose Daily Risk-Adjusted Returns
28 March, 2025
Synopsis:
Investors often focus on high returns without fully considering the associated risks.
AMCs now require daily disclosure of the Information Ratio (IR) for equity mutual funds.
The Information Ratio helps assess how efficiently a fund generates returns relative to risk.
SEBI regulation allows better fund comparisons, increased risk awareness, and greater fund manager accountability.
Greater transparency ensures investors make informed decisions based on returns and risk.
Imagine you're choosing between two job offers. Job A offers a high salary but has unpredictable work hours, intense pressure, and frequent weekend work. Job B provides a stable income, a structured work schedule, and a better work-life balance. While Job A seems financially rewarding, the added stress and uncertainty might not be worth it for everyone. The best decision isn’t just about earning more but also understanding the challenges that come with it.
The same logic applies to mutual fund investments. Investors often chase high returns without fully considering the risks of achieving them. To bridge this gap, the Securities and Exchange Board of India (SEBI) has mandated that all Asset Management Companies (AMCs) disclose the Information Ratio (IR) of their equity-oriented mutual fund schemes daily. This move aims to provide investors with better insights into the risk-adjusted returns of their investments.
What is the Information Ratio and how to calculate?
The Information Ratio (IR) is a financial metric that helps investors evaluate how well a mutual fund has performed relative to its benchmark while considering the level of risk taken. It is calculated by dividing a fund’s excess return over its benchmark by the volatility of those returns.
A higher IR indicates that a fund has effectively managed risk while delivering returns.
A lower IR suggests that the fund's returns may not justify the risks taken.
For Example, let's compare two large-cap equity funds over a 3-year period:
Fund A:
Average annual return: 15%
Benchmark return: 12%
Excess return: 3% (15% - 12%)
Tracking Error: 4% (standard deviation of excess returns)
Information Ratio: 0.75 (3% ÷ 4%)
Fund B:
Average annual return: 17%
Benchmark return: 12%
Excess return: 5% (17% - 12%)
Tracking Error: 8% (standard deviation of excess returns)
Information Ratio: 0.625 (5% ÷ 8%)
What This Means: While Fund B delivered a higher absolute return (17% vs 15%), Fund A has a higher Information Ratio (0.75 vs 0.625). This indicates that Fund A generated more consistent excess returns relative to the risk taken.
Fund A's outperformance was more reliable and achieved with lower volatility. Fund B, despite higher returns, achieved them with greater volatility and inconsistency.
For a risk-aware investor, Fund A might be preferable despite its lower absolute return, as it demonstrates more skill in consistently outperforming the benchmark with less volatility. A more aggressive investor comfortable with higher volatility might still prefer Fund B for its higher absolute returns.
IR = (Fund Return - Benchmark Return) / Tracking Error
Excess Return: The difference between the returns on funds and the benchmark return.
Benchmark: The standard (Tier 1 benchmark) used for comparison, ensuring uniformity across mutual funds.
Volatility (Standard Deviation): Measures how much the excess return fluctuates, calculated using daily return data.
Daily Portfolio Return: Determined using a simple arithmetic method.
How does this impact investors?
This regulation benefits investors in several key ways:
Better Comparisons: Investors can now compare funds based on absolute returns and how efficiently those returns were achieved.
Risk Awareness: Instead of looking at past performance, investors can now assess whether a fund’s returns align with their risk appetite.
Fund Manager Accountability: Regular disclosure of the IR puts fund managers under more excellent analysis, encouraging them to manage risk more effectively.
Why Transparency Matters
Investing is not just about chasing high returns; understanding the risks behind those returns is just as important. SEBI’s mandate for daily disclosure of the Information Ratio (IR) ensures that investors can assess performance and risk before making decisions. By providing a clearer picture of how efficiently a fund generates returns, this move helps investors choose funds that align with their financial objectives. Greater transparency leads to better decision-making and a more responsible investment approach.
Choosing an investment is not just about picking the highest return; a job is not just about the highest salary. It is about weighing the risks and rewards together. SEBI’s move to enforce daily risk-adjusted return disclosures helps investors make decisions that align with their financial objectives and risk appetite, ensuring a more transparent and informed investment process.
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