What is the difference between Total Return Index and Price Return Index?

What is the difference between Total Return Index and Price Return Index?

In February 2018, SEBI's updated measure for assessing the performance of mutual funds shifted from "Price Return Index" to "Total Return Index".

There are two measures of a mutual fund's return: the total return and the time-weighted return. The former focuses on capital gains or losses while the latter takes into account dividends as well.

What do you mean by benchmarking?
A mutual fund is compared to and evaluates by, various market indices to see how the price of the mutual fund changes with respect to each other. This is called "benchmarking". In addition, it is also called an index and equals the sum of its components. When one component changes in value, so does the benchmark value.

A fund is considered outperforming if it has a better performance than its benchmark, and underperforming if it has worse performance.

A comparison of the total return index and price return indices.
Although mutual funds generate returns in two ways -- capital appreciation (an increase in share price) and dividends -- until February 2018, only capital appreciation was considered for performance mapping.

Measuring only the capital appreciation of a stock fails to capture other important aspects of stock-holding such as reinvested dividends, which are equally beneficial. One such measuring tool is the total return index, which calculates how well an investment has performed and accounts for everything from price change to dividends with respect to time.

The introduction of the Trade Return Index has improved transparency and credibility in funds. If you compare two identical portfolios of securities, then it will always show better returns mapped over the Price return index than over other indices that are not transparent.

PRI was sometimes vague and misleading before because it overstated the performance of a mutual fund. This led more people to invest in the funds because of their supposed exceptional performance. TRI provides more transparency in its evaluations so actual statistics can be reflected to investors, thus eliminating any ambiguity or deception that may confuse investors.

What is it like as an investor?
Though your investment fund may be performing according to its benchmarks, it is essential for investors to understand how their investments are faring in the current market conditions. The implementation of TRI has caused a decrease in performance for even passive funds which had previously outperformed their respective industry indices because they no longer meet these criteria.

When PRI was the measuring parameter, funds with higher AUM generally underperformed their benchmarks. This trend reversed as AUM increased.

When you find that your fund is no longer outperforming others, it is time to review your investment portfolio. You should remove consistently underperforming funds in order to keep the balance and goals of your portfolio aligned.

Best wishes for investing!

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