How Informative is Information Ratio?

Equity indices in India have been reaching new all-time highs regularly over the past few weeks. One reason for this performance is the strong support from domestic institutions, especially mutual funds. The latest data for June mutual funds shows that net inflows into equity mutual funds surged 17 per cent sequentially to a record high of ₹40,608 crore, bolstered by an inflow of ₹14,370 crore from 11 new equity fund offerings. [EasyDNNnews:PaidContentStart]

Additionally, gross inflows from systematic investment plans reached a new high of ₹21,262 crore, further boosting the net inflows. Investor trust in mutual funds has been driven by high-decibel promotions from the industry body and proactive regulations. To enhance decision-making for investors, on June 28, the Securities and Exchange Board of India proposed a new measure to improve transparency in mutual fund performance: the mandatory disclosure of risk-adjusted returns using the information ratio (IR). 

This aims to provide investors with a clearer picture of fund performance. IR essentially tells you how much excess return (return above the benchmark) you are getting relative to the amount of risk you are taking. The key question is whether this new metric will genuinely help investors make betterinformed decisions or complicate the landscape further. The IR varies over time and across different fund categories and so its effectiveness as a performance measure for mutual fund managers is still not very clear. 

Because the IR encourages managers to closely follow the benchmark, it should be supplemented with measures like ‘active share’ to control the portfolio’s activity level. Lastly, a long-term track record is essential to distinguish skilled managers from lucky ones, as luck is generally not persistent over time. Therefore, I believe that it is a step in the right direction but needs to be supplemented with other metrics to make it more informative for investors. 

Shashikant Singh
Executive Editor

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