SEBI Focuses on Risk in Mutual Funds: Proposes Disclosure of Risk-Adjusted Returns

To enhance transparency and help investors better understand their scheme's returns in relation to its volatility, the Securities and Exchange Board of India (SEBI) has proposed mandatory disclosure of the Information Ratio (IR).

The IR measures the ratio of Tracking Difference (TD) to Tracking Error (TE) of a scheme portfolio over a specific period.

SEBI has issued a consultation paper suggesting that mutual funds disclose risk-adjusted returns alongside standard returns.

According to SEBI, the "Risk Adjusted Return" (RAR) provides a more comprehensive measure of a scheme’s performance by quantifying the return generated for each unit of risk taken.

Currently, some fund houses disclose RAR, but the calculation methods vary, and not all fund houses provide this information. For example, SEBI noted that out of 39 fund houses with equity schemes, only 33 disclose RAR.

For hybrid schemes, only 27 out of 36 fund houses disclose their risk-adjusted return numbers.

SEBI now proposes making this disclosure mandatory and standardizing the IR as the required risk-adjusted ratio.

The IR is the ratio of TD, the excess return over the benchmark, to TE, the standard deviation of the excess return. A higher IR indicates a better RAR, showing how much excess return a fund generates per unit of risk taken.

SEBI suggests that IR disclosures be mandatory in all publicly available spaces, such as a mutual fund’s website, Scheme Information Document, and the Association of Mutual Funds of India (AMFI) website.

However, schemes less than six months old would be exempt from publishing their IRs.

This proposal highlights SEBI's emphasis on revealing the risk level of investments, not just the returns.

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