What is total return index?

The total return index (TRI) is a type of equity index that tracks both the capital gains and assumes that any cash distributions, such as dividends, are reinvested back into the index. Looking at an index’s total return displays a more accurate representation of the index’s performance. By assuming dividends are reinvested, you effectively account for stocks in an index that do not issue dividends and instead, reinvest their earnings within the underlying company.

Total returns stand in contrast to price returns, which do not take into account dividends and cash payouts. Including dividends makes a significant difference in the return of the fund. TRI is commonly used as the primary benchmarks for comparing fund performance elsewhere, but in India this trend is just taking off. Historically, Indian indices have always been tracked for the price return, but now you can find historical total returns data for most indices, although they are not widely tracked yet.

From 1^st February 2018, all mutual fund schemes were mandated by SEBI to use TRI to benchmark their performance.

TRI helps in giving the right picture of the real alpha of a mutual fund as dividends are generally paid to the mutual fund directly & added to the NAV and is thus a better benchmark. The returns that are shown currently may look overstated as dividends are not added in benchmark returns calculation.

It is generally seen that there is a difference of about 1.5% returns between a normal index & TRI index. The typical dividend yield on SENSEX/NIFTY benchmarks is about 1.5% p.a, which means that the TRI benchmark will be harder to beat by about 150 bps p.a. Thus the number of equity mutual funds beating the benchmark will drop significantly.

Thus let us say that there was a particular scheme which claimed to beat the benchmark by 2.5% p.a. That outperformance will now come down to 1%. Apart from the evaluation part, nothing is going to change. For example, if a scheme was benchmarked against Nifty 50 earlier, it is being benchmarked against the Nifty 50 TRI currently.

From an investor standpoint, TRI would give the actual picture of what exactly he or she earns from a mutual fund investment. From the standpoint of fund managers, it will make them work a little harder to make the right stock pick.

Let us just have a look at the index published for some major indices:

^*Annualized

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Sabyasachi Paul has been associated with equity research and advisory on equity markets in India for over 10 years & currently heads the equity research desk of Eastern Financiers Ltd, Kolkata. He also manages a portfolio on the online platform Kristal. Find link to the strategy named ‘The Tortoise’