Mandatory disclosure of risk-adjusted mutual fund returns on the cards

The Securities and Exchange Board of India (Sebi), the country's capital market regulator, has proposed that along with the past returns of a mutual scheme, "risk-adjusted" returns should also be disclosed, in a bid to ensure that investors make informed decisions. While a normal investment return typically means the absolute or nominal return delivered by an investment over a given period of time, a risk-adjusted return (RAR) takes into account the degree of risk associated with an investment in addition to the return generated. Hence, a risk-adjusted return offers a more comprehensive measure of performance by considering how much risk was undertaken to achieve the return. 

Sebi has invited comments on the proposal from the public till July 19.

Here are five key takeaways from this development: 

• It is desirable that mutual fund schemes' risk-adjusted returns be disclosed along with their performances given the significance of volatility in determining the suitability of MF schemes, Sebi wrote in its consultation paper.
• Currently, the regulatory framework does not mandate the disclosure of risk-adjusted returns with the absolute returns of mutual fund schemes.
• There is no uniform procedure followed by asset management companies (AMCs) to report the risk-adjusted returns of their mutual fund schemes.
• "Information Ratio (IR) is an established financial ratio to measure the RAR of the 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 it also attempts to identify the consistency of the performance by incorporating a tracking error or standard deviation component into the calculation," Sebi said.
• Sebi has also proposed a methodology for calculating information ratios for different categories of schemes, in a bid to bring uniformity across different mutual funds. 

What is the information ratio?

There are several metrics used to calculate risk-adjusted returns, information ratio being one of them. These metrics assess the relationship between investment returns and volatility or risk, hence providing a clearer picture of investment performance especially when comparing investments with varying risk levels or strategies.