SEBI: Mutual Funds Must Disclose Risk-Adjusted Returns

resr 5paisa Research Team

Last Updated: 21st January 2025 - 04:35 pm

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To enhance transparency in disclosures by Asset Management Companies (AMCs) and facilitate better investor decision-making, SEBI issued a directive on Friday requiring mutual funds to disclose the information ratio (IR) of a scheme alongside its performance data.

The disclosure of IR, a financial metric used to evaluate the Risk-Adjusted Return (RAR) of a scheme portfolio, will apply specifically to equity-oriented schemes.

"Given the importance of performance volatility in assessing the suitability of mutual fund schemes, the information ratio serves as a well-established measure to evaluate the RAR of a portfolio.

"It is commonly utilized to assess a portfolio manager’s skill in generating excess returns compared to a benchmark while also accounting for performance consistency by incorporating standard deviation and risk factors," SEBI stated.

Purpose and Impact of Information Ratio Disclosure

By mandating the disclosure of the information ratio, SEBI aims to provide investors with deeper insights into a fund’s performance beyond absolute returns. The IR helps in determining whether the fund manager is consistently generating risk-adjusted returns above the benchmark, making it an essential metric for investors when comparing different mutual fund schemes.

Higher IR values indicate that the fund manager has successfully generated excess returns while effectively managing risk. Conversely, a low or negative IR suggests that the fund has underperformed relative to its benchmark when adjusted for volatility. This transparency is expected to help investors make well-informed investment decisions by considering not just past returns but also the stability and consistency of those returns.

Implementation and Industry Compliance

In its circular, SEBI mandated that mutual funds display the IR of a scheme portfolio on their websites alongside performance disclosures, updating the information daily. This move ensures real-time availability of crucial risk-adjusted performance data for investors.

Additionally, the industry body AMFI must ensure that these disclosures are available on its website in a standardized, downloadable (spreadsheet) and machine-readable format. By providing data in a structured and comparable manner, AMFI aims to improve accessibility and usability for investors, analysts, and financial advisors.

To ensure consistency across mutual funds, SEBI has also introduced a standardized methodology for calculating the IR across different categories of mutual fund schemes. This uniform approach will help eliminate discrepancies in how different fund houses report IR, enabling fair comparisons across the industry.

Implications for Mutual Fund Investors

For retail and institutional investors, the introduction of IR disclosures will serve as a valuable tool for evaluating mutual fund schemes. Investors can now assess whether a fund’s returns are driven by strategic investment decisions or merely by taking on excessive risk. With this additional layer of transparency, investors will be better equipped to align their investments with their financial goals and risk tolerance.

Experts believe that this move will further strengthen investor confidence in mutual funds as an asset class. Since the IR reflects a fund manager’s ability to deliver superior risk-adjusted returns, fund houses with consistently high IRs are likely to attract more investors.

These provisions will take effect within three months from the date of the circular's issuance, allowing AMCs sufficient time to update their reporting mechanisms and ensure compliance with SEBI’s guidelines.

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