MF: Is your fund investment worth the risk? Zerodha explains the return information factor

The Securities and Exchange Board of India (SEBI) has mandated mutual funds to disclose information ratio (IR) as a new metric for assessing risk-adjusted returns (RAR) from equity-oriented schemes. The disclosure of IR, a financial ratio used to measure the risk-adjusted return (RAR) of a portfolio of schemes, will only apply to equity-oriented schemes.

The information indicator has been designed specifically for equity mutual fund programs. As per SEBI guidelines, mutual funds are required to display the scheme’s information factor along with other performance data on their website on a daily basis.

Zerodha breaks down the functions:

1. Zerodha claims that the Information Ratio (IR) helps assess the performance of a fund compared to its benchmark, taking into account the risks involved. It shows how well a fund manager has performed over time at effectively managing risk.

Explanation: When assessing the suitability of mutual fund schemes, assessing the variability of performance is crucial. The Information Ratio (IR) is a well-known financial metric used to measure the risk-adjusted rate of return of a program portfolio. This metric not only assesses a portfolio manager’s proficiency in generating above-average returns compared to a benchmark, but also helps determine the consistency of performance by taking into account standard deviation and risk.

2. Simply put, IR tells you how much additional return a fund achieves for each unit of risk incurred compared to its benchmark. It focuses on the consistency and skills of the fund manager, not just the good years spent in the bull market.

For example, manager A provides a 30% return with low risk, while manager B achieves a 40% return but takes more risk.

The Information Ratio (IR) helps determine which manager is better at generating returns while managing the associated risks.

Explanation: SEBI’s move is aimed at increasing the transparency of information disclosed by AMCs, which will ultimately help investors make informed decisions.

3. This is important because funds that take on too much risk may perform well in good times but may struggle in difficult times. IR helps you understand whether the returns are worth the risk.

Other metrics, such as the Beta and Sharpe ratio, focus on different aspects of performance. However, IR combines both risk and return to give a clearer picture of a fund’s true performance.

Clarification: SEBI has emphasized the importance of the information ratio as a key indicator of a fund’s performance in relation to its risk. By including standard deviation, which measures volatility, the IR effectively captures both returns and consistency of performance.

4. Why is it useful?

High returns do not always mean a good investment if the fund takes too much risk. Information Ratio (IR) analysis helps investors make better choices by considering both return and risk.

Clarification: SEBI has mandated mutual funds to publish the portfolio scheme information factor along with performance details on their websites on a daily basis. Amfi is responsible for ensuring that this information is easily accessible on its website in a consistent, downloadable (spreadsheet) and machine-readable format.