The Securities and Exchange Board of India (SEBI) recently came out with a new disclosure regulation for mutual funds with regard to Risk Adjusted Returns, which should represent a more holistic measure of a scheme’s performance. It asked the fund houses to disclose Information Ratio for their schemes on daily basis.
“Considering the significance of volatility of performance in determining the suitability of MF schemes, Information Ratio (IR)is an established financial ratio to measure the RAR of any scheme portfolio. It is often used as a measure of a portfolio manager’s level of skill and ability to generate excess returns, relative to a benchmark and also attempts to identify the consistency of the performance by incorporating standard deviation/risk factor into the calculation,” SEBI said.
Mutual funds/AMCs should disclose IR of a scheme portfolio on their website along with performance disclosures on a daily basis. AMFI is required to ensure that such disclosure is available on its website in a comparable, downloadable (spreadsheet) and machine readable format, the regulator further said.
IR metrics
Information ratio is arrived at by dividing the active return of a portfolio by tracking error. Is tracking error correct? Or is it standard deviation? Active return of portfolio is excess returns generated by the fund over a benchmark index.
The information ratio helps investors analyse whether a fund manager has achieved superior risk adjusted return on a consistent basis. If the ratio is higher, it indicates the superior performance of fund manager with respect to others of comparable schemes. In other words, a higher IR also means better chances of achieving consistent returns.
High returns don’t always mean a good investment if the fund is taking on too much risk. Looking at the Information Ratio (IR) helps investors make better choices by considering both return and risk.
Analysing IR
According to Angel One, a good information ratio (IR) is typically above 0.5, signifying that an investment or portfolio manager is generating returns that surpass the market benchmark after considering the risks taken. An IR below 0.5 suggests that the manager may not be effectively utilising the skills to outperform the market, making it a less favourable investment choice.
The negative information ratio, also known as the Negative IR, is a measure used in finance to evaluate the underperformance of investment portfolios. “A negative IR suggests that the portfolio’s returns during negative periods are not meeting expectations, highlighting the need for risk management,” the brokerage firm added.
SEBI has been in the forefront to bring in transparency, especially with respect to cost structure and performance metrics of regulated products. In November, it asked funds to provide separate disclosures for direct and regular plan schemes in their half-yearly financial results. Fund houses was asked to disclose specific financial metrics, such as expenses, returns, and yield, separately for direct and regular plans. Besides, MFs were also directed come out with colour-theme based on risk-o-meter of the scheme: low risk marked in Irish green; low to moderate risk in Chartreuse; moderate risk in neon yellow; moderately high risk in caramel; high risk in dark orange; and very high risk in red.
SEBI initiatives on this front are praiseworthy these proposals are aimed at facilitating enhanced transparency, ease of comprehension and a standardised approach towards disclosures by the mutual fund industry. Now, the ball is in fundhouses’ court to take the message to the masses and explain the nuances of MF investing for overall benefit all stakeholders.