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. 

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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.