The Securities and Exchange Board of India (SEBI) has mandated mutual funds to disclose the Information Ratio (IR) as a new metric for evaluating the risk-adjusted returns (RAR) of equity-oriented schemes. Disclosure of IR, a financial metric used to measure the Risk-adjusted Return (RAR) of a scheme portfolio, will only be applicable to equity-oriented schemes.
The Information Ratio is specifically designed for equity mutual fund schemes. As per SEBI guidelines, mutual funds are required to display the Information Ratio of a scheme, along with other performance data, on their website daily.
Zerodha breaks down the features:
1. Zerodha says the Information Ratio (IR) helps assess a fund’s performance against its benchmark while considering the risk involved. It shows how well a fund manager performs over time while managing risk effectively.
Explanation: When evaluating the appropriateness of mutual fund schemes, assessing the volatility of performance is crucial. The Information Ratio (IR) is a well-known financial metric used to gauge the risk-adjusted return of a scheme portfolio. This ratio not only assesses a portfolio manager’s proficiency in generating above-average returns compared to a benchmark but also helps in determining the consistency of performance by factoring in standard deviation and risk.
2. Simply put, IR tells you how much extra return a fund makes for each unit of risk it takes, compared to its benchmark. It focuses on the consistency and skill of the fund manager, not just good years in a bull market.
For example, Manager A delivers a 30% return with low risk, while Manager B achieves a 40% return but takes on higher risk.
The Information Ratio (IR) helps determine which manager is better at generating returns while managing the risks involved.
Explanation: SEBI’s action aims to enhance the transparency of disclosures from AMCs, ultimately helping investors make informed decisions.
3. This is important because funds that take on too much risk might perform well in good times but may struggle in tough times. IR helps you understand if the returns are worth the risk.
Other metrics like Beta and Sharpe ratio focus on different aspects of performance. But IR combines both risk and return to give a clearer picture of a fund’s true performance.
Explanation: SEBI underscored the significance of the Information Ratio as a crucial indicator of a fund’s performance relative to its risk. By factoring in the standard deviation, which measures volatility, the IR effectively encapsulates both returns and performance consistency.
4. Why is this useful?
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.
Explanation: SEBI has mandated mutual funds to publish the information ratio of a portfolio scheme on their websites daily, alongside performance details. Amfi is responsible for ensuring that this information is easily accessible on its website in a consistent, downloadable (spreadsheet), and machine-readable format.