Impact of Total Return Index on Mutual Fund Investors

If you are planning on investing in mutual funds, it is essential that you understand not just the functioning of these funds, but also how certain things that surround these funds impact its performance. When you invest in mutual funds, there are two investment options - you can either opt for a growth option or for a IDCW option. So if you are someone with a long term investment horizon, the growth option might do the needful. In the growth investment option, the profits made by the scheme are reinvested back in the fund. As the mutual fund grows and continues to help capital appreciation, a growth option can add value to a fund’s net asset value (NAV) in the long run.

If you are someone who is investing in mutual funds for income, then the IDCW option might work out in your favor. In the IDCW option, when the mutual fund performs and makes profits the fund manager issues bonuses to investors in the form of IDCW. However, a IDCW is only offered if the fund is able to perform. Also, the intervals at which investors will receive IDCW is uncertain and solely at the discretion of the fund manager.

Understanding benchmark

A benchmark, which is also referred to as an index in mutual funds, is the collective number of securities purchased at the existing market price. It is the measurement used to track the performance of a mutual fund.

What is the Total Return Index (TRI)? How is it different from the old Price Return Index (PRI)?

Securities and Exchange Board of India (SEBI), the regulator of mutual funds mandated the use of Total Return Index (TRI) for mutual fund schemes to benchmark their performance here in India from 1st February, 2018. The primary purpose of introducing TRI and replacing it with the basic index is to allow a mutual fund scheme to clearly display its performance as compared to the performance of the underlying index which it is tracking. For those who are not aware, the previous indices did not include IDCW. On an average, the IDCW takes up roughly 1.5 per cent from the index. The previous Price Return Index (PRI) only tracked capital gains of the mutual fund scheme. But a TRI is an index that does the job of tracking both the capital gains as well as any cash distribution that has happened in the form of IDCW. Basically, it acknowledges the IDCW component which was neglected by the previously functional Price Return Index (PRI).

How does the Total Return Index (TRI) impact the investment strategies of a mutual fund investor?

The shift of benchmarking a mutual fund’s performance from Price Return Index (PRI) to Total Return Index (TRI) may or may not impact the investment strategies of a mutual fund investor. This shift in benchmarking may impact an investor if he/she is planning to shift from active mutual fund investing to passive mutual fund investing.

How?

Introduction of TRI has made things credible and transparent for mutual fund investors. In India, actively managed mutual funds, over a period of long term, have outperformed the benchmark indices. But with the introduction of Total Return Index, if the mutual funds scheme you invested in isn’t giving desired results over a course of three to five years, then investors might have to do a thorough revaluation of their investments. In case you make a switch and if still your expectations aren’t met, then you may have to shift to passively managed funds like index funds or exchange traded funds ( ETFs) which are available at a much affordable expense ratio.

The bottom line

No matter which type of mutual fund you invest in, it is necessary to set some long term and short term financial goals. Having a defined set of financial goals also help in effective financial planning. Once you understand your goals, investing in financial schemes becomes easier and you are able to spread your investments across effective investment vehicles. If you want to invest in mutual funds to reach your ultimate financial goal, you not only need to have a defined set of goals, but you also need to understand your risk appetite. That’s because mutual funds like equity funds invest predominantly in equity and equity related instruments. And we all know that investments exposed to volatile markets like equity are at constant risk. Also, capital gains from such investments is never guaranteed. So if you are planning on investing in mutual funds, make sure that you have a defined goal and also understand your risk appetite. Also, do adequate research and find out everything you need about the fund before you invest in it. If needed, consult a financial advisor or explore our mutual fund app for more information.

Mutual Fund Investments are subject to market risks, read all scheme related documents carefully.