Description

Copyright infringement not intended

Picture Courtesy: The Hindu

Context:

The Securities and Exchange Board of India (SEBI) has directed mutual funds to disclose the information ratio (IR) of a scheme along with performance disclosure on a daily basis to enhance transparency and aid investor decision-making.

About the Information Ratio (IR)

It measures the performance of a portfolio or financial asset in relation to a benchmark, considering the volatility of its returns. It helps assess how well an asset is doing compared to a market index like Nifty 50 or other relevant benchmarks.

How is the Information Ratio calculated?

The Information Ratio is calculated using the following formula: IR = (Portfolio Rate of Returns – Benchmark Rate of Returns) / Tracking Error

Here, the portfolio rate of returns is the actual return generated by the investment, while the benchmark rate of returns is the return generated by the chosen index (such as Nifty 50).

The tracking error, a measure of volatility, shows how closely the portfolio follows its benchmark’s returns. A higher tracking error indicates more volatility, while a lower tracking error suggests more consistency in exceeding the benchmark.

Components of the Information Ratio

Portfolio Rate of Returns: This is the return generated by the investment or mutual fund.
Benchmark Rate of Returns: This represents the return generated by the market index or the relevant benchmark.
Tracking Error: This measures the consistency with which the portfolio tracks and exceeds the benchmark. It is the standard deviation of the difference in returns between the portfolio and the benchmark.

Tracking error plays a critical role in determining whether a portfolio is consistently outperforming the benchmark or if there’s high volatility in its performance.

How does the Information Ratio help in comparing different fund managers?

The Information Ratio is used to compare the performance of fund managers who follow similar investment strategies.

A higher IR indicates that the fund manager is able to generate superior returns with a consistent performance over time, relative to the benchmark. This makes it a vital metric when selecting between fund managers, as it shows who has a greater ability to add value beyond general market returns.

Securities and Exchange Board of India (SEBI) was established in 1988 as a non-statutory body and became a statutory body in 1992 to overseas capital and securities markets.

Must Read Articles:

Securities and Exchange Board of India (SEBI)

Source:

The Hindu

PRACTICE QUESTION

Q. Consider the following statements:

1. Taxes are considered as part of capital receipt.

2. Capital markets include the bond market and the stock market.

3. IPOs mark the transition from private to public ownership.

How many of the above statements are correct?

A) Only one

B) Only two

C) All three

D) None

Answer: B

Explanation:

Statement 1 is incorrect:

Taxes are not considered capital receipts because they do not create liabilities or reduce assets. Instead, taxes are revenue receipts, which are related to an organization's day-to-day operations.

Statement 2 is correct:

Capital markets include the bond market and the stock market. Capital markets are financial markets that allow investors to buy and sell long-term financial assets like stocks, bonds, and other securities.

Statement 3 is correct:

An Initial Public Offering (IPO) is the first time a private company sells shares to the public, allowing general investors to buy a piece of the company on a stock exchange. This process involves working with investment banks to file paperwork and market the offering to potential investors. IPOs mark the transition from private to public ownership, raising capital for expansion, research, development, or debt repayment.