Sebi's information ratio proposal: Clear insight or investor overload?
On 28 June, the Securities and Exchange Board of India (SEBI) proposed a new measure to improve transparency in mutual fund performance: the mandatory disclosure of risk-adjusted returns using the information ratio. While this aims to provide investors with a clearer picture of fund performance, some experts are concerned it might lead to information overload for retail investors.
The key question, therefore, is whether this new metric will genuinely help investors make better and informed decisions or just complicate the landscape further.
The information ratio measures a fund's outperformance against a benchmark, divided by the volatility of this outperformance. This metric aims to convey not just outperformance but also its consistency.
The Sebi's move aims to address a discrepancy in traditional or existing measures, wherein past one- or three-year returns often fail to capture the associated risks, leading investors to sometimes choose funds based solely on recent performances.
For instance, consider two funds: Fund A and Fund B. Fund A has delivered consistent, moderate returns over five years, while Fund B has shown spectacular returns in the last year. Investors might gravitate towards Fund B due to its impressive recent performance, unaware that its higher returns come with higher risk, implying significantly higher volatility and potential for substantial losses during market downturns.
Therefore, it's essential to evaluate the risks taken to generate returns, ensuring the fund's risk level aligns with an investor's risk appetite and financial goals, and safeguarding financial stability.
Most fund houses use the sharpe ratio to measure risk-adjusted returns, showing how much excess return you make for the extra
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