Are You a Mutual Fund Investor? Here’s What SEBI’s New Regulation on Risk-Adjusted Returns Means for You!

Purvang Mehta -

Imagine you’re looking at two mutual fund managers. Manager A delivers a 30% return with low risk, while Manager B boasts a 40% return but takes on much higher risks. Who would you choose?

This decision can be tricky, especially when most investors only look at past returns without considering the risks taken to achieve them. SEBI’s latest regulation aims to solve this problem and help you make smarter investment choices by introducing a powerful new metric: the Information Ratio (IR).

What You’ll Learn in This Blog:

  • What makes the Information Ratio (IR) a game-changer for equity mutual funds?
  • Why has SEBI taken this bold step to mandate IR disclosure?
  • How does IR reveal the true story behind mutual fund returns?
  • The secret to making smarter, risk-aware investment decisions using IR.

The Why Behind SEBI’s New Regulation

For years, mutual fund investors in India have relied heavily on past performance as the key metric for evaluating funds. But here’s the catch—high returns can sometimes mask the fact that a fund took on excessive risk to achieve them. This can lead to unpleasant surprises during market downturns.

SEBI recognized this gap and introduced a requirement for all equity mutual fund schemes to disclose their Information Ratio (IR) on a daily basis. The goal? To give investors like you a clearer picture of not just how much return a fund delivers, but how skillfully and consistently it manages risk to achieve those returns.

So, what is the Information Ratio (IR)?

The Information Ratio is like a report card for a mutual fund manager’s performance. It measures how much extra return a fund generates compared to its benchmark while taking into account the level of risk involved.

Think of it this way: if a mutual fund delivers high returns but with wild fluctuations, its IR might not look so good. On the other hand, a fund that delivers slightly lower returns but does so with greater stability and lower risk will have a higher IR.

The formula for IR is simple:

What does this mean in plain language? It tells you whether the fund manager is delivering value for the risks they’re taking.

Why This Matters to You

Here’s why SEBI’s move is a big deal for investors:

  1. Transparency Like Never Before
    Starting now, every equity mutual fund will display its Information Ratio on its website daily. This makes it easier for you to compare funds based on their risk-adjusted returns.
  2. A Uniform Standard
    SEBI has mandated that all fund houses calculate IR using the same formula, ensuring consistency across the industry.
  3. Better Investor Education
    SEBI and the Association of Mutual Funds in India (AMFI) are rolling out awareness campaigns to help investors understand IR and its importance. Soon, you’ll find easy-to-read guides, illustrations, and examples that explain how to interpret this metric.
  4. Empowering Smarter Choices
    With IR, you can identify funds that don’t just shine in bull markets but also hold their ground when the going gets tough. It’s a tool that helps you focus on consistency and quality rather than just headline returns.

A Quick Example

Let’s revisit the two managers:

  • Manager A: 30% return with low risk.
  • Manager B: 40% return with high risk.

Without IR, you might lean toward Manager B. But with IR in the picture, you’d see that Manager A is actually the more consistent performer, delivering better value for the risks taken.

How to Use the IR

When you look at a mutual fund’s performance, don’t just glance at its past returns. Check its IR:

  • A higher IR means the fund manager is generating good returns relative to the risks taken.
  • A negative IR signals that the fund is underperforming its benchmark, even after accounting for risk.

The key is to look for funds with a consistently high IR over time, as this reflects both skill and stability.

The Bottom Line

SEBI’s new regulation is a step forward in making mutual fund investments more transparent and investor-friendly. By focusing on the Information Ratio, you can make better decisions that align with your financial goals and risk tolerance.

So, the next time you evaluate a mutual fund, don’t just chase high returns. Look for the Information Ratio—it might just be your key to a smarter, safer investment.

Want to Read the Full SEBI Circular?
For a detailed look at SEBI’s new regulation on risk-adjusted returns, you can access the official circular here.