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Evaluating Stock Performance through Total Return Index: Explained

  • Vrinda Mathur
  • Apr 09, 2024
  • Updated on: Oct 26, 2023
Evaluating Stock Performance through Total Return Index: Explained title banner

Following SEBI's change on mutual fund benchmarking and performance measurement, the benchmark has shifted from Price Return Index to Total Return Index. Since February 2018, the procedure has evolved and increased transparency.


Unlike PRI, which focuses just on capital gains or losses and ignores dividends, TRI in mutual funds ensures a comprehensive picture of the fund for comparing and benchmarking. Let's take a closer look at what they are and how they differ.


Investors use a variety of indexes to choose whether or not to invest in mutual funds. The total return index, or TRI, is a useful equity index benchmark that captures the returns from the movement of constituent stock prices and dividend payouts. We will go over how it works, how to utilize it, its features, and benefits. 


First, let us define the term "total return index."


What is the Total Return Index


When investing, we frequently evaluate a stock's previous performance to predict its future performance. The total return index was developed to track both capital appreciation and dividend returns. It demonstrates the impact of dividend payouts on an investor's results.


The total return index takes dividend reinvestment into account. When using the total return index, users can incorporate all aspects of the return, not simply price change. It measures the index's performance by tracking capital gains and any cash disbursements such as dividends or interest. As a result, it provides stockholders with a more complete view. 


Assuming dividends are reinvested, the total return index includes all equities that do not pay dividends but reinvest in the underlying company. 


A total return index is a sort of equity index that monitors both capital gains and cash payments attributable to the index's components, such as dividends or interest. A total return analysis of an index provides a more realistic depiction of the index's performance to shareholders.It essentially adjusts for stocks in an index that do not pay dividends and instead reinvest their earnings within the underlying company as retained earnings by assuming dividends are reinvested. A total return index differs from a price return or nominal index.


A total return index may be considered more accurate than other indices that do not account for dividend or distribution action, such as those that focus just on annual yield.


For example, an investment could provide a 4% yearly return while also increasing the share price by 6%. While the yield only reflects a portion of the growth, the total return includes both yields and the increasing value of the shares to represent a 10% rise. If the same index lost 4% instead of gaining 6% in share price, the total return would be 0%.


How to calculate the Total Return Index?

A total return index can be calculated using dollar, euro, or other currency values. The computation steps are as follows:


To compute the TRI, we must first account for the dividend paid. The first step is to divide the dividends paid over time by the same divisor that is used to generate the index points, commonly known as the index base cap. It offers us the value of the dividend paid out per index point, as expressed by the equation below:


Dividend Indexed (Dt) = Dividend Paid / Base Cap Index


The price return index for the day is then adjusted by combining the dividend and price change indexes. To accomplish so, use the following formula:


(Today's PR Index + Dividend Index)/Previous PR Index


Finally, the total return index is computed by applying the price return index adjustments to the total return index, which accounts for the entire history of dividend payments. This value is multiplied by the TRI index from the previous day. It is represented as follows:


Total Return Index = [1+ (Today's PR Index +Indexed Dividend)/Previous PR Index-1]


The TR index allows retail investors to compare their returns on mutual fund investments to the performance of a fund manager using indices such as the S&P 500. Using the TR index to compare the success of various investment possibilities provides a more precise assessment of return on investment.


Using the total return index instead of the price return index will have a substantial impact on an investor's long-term strategy. They can more properly assess the difference in performance using TRI than the price return index.


As a result, TRI computation entails three steps: calculating the dividend per index point, adjusting the price return index, and applying the adjustment to an earlier day's TRI index level.


The TR index is a more useful benchmark for determining the real returns generated by mutual fund holdings. TRI is more extensively used to calculate mutual fund returns than traditional price return indexes in all major developed economies. Even when calculating the growth generated by equities stocks, dividends must be reinvested. As a result, TRI aids in seeing the big picture when assessing equity fund returns.


Total Return Index vs Price Return Index


When you invest in Mutual Munds, you get two kinds of returns: capital appreciation and dividends. Capital appreciation is the increase in the share price of the fund above the price at which you invested.


Equities, in particular, rely on both capital appreciation and dividend payments. However, until February 2018, only capital appreciation was used to map a fund's success.


The Price Return Index parameter only considered capital appreciation, which is only half of the picture. Dividends that are reinvested play a significant part in equities since they are invested over a longer period of time.


When these dividends are paid out, the overall return of equities rises, causing them to outperform the benchmark. The total return index is one such index that considers the entire parameters when mapping a fund's performance. As an example, consider the S&P 500. One example of a total return index is the S&P 500 Total Return Index (SPTR). The total return indexes work in a similar manner to many mutual funds, with all cash distributions automatically reinvested back into the fund. While most total return indexes are equity-based, there exist total return indexes for bonds that presume that all coupon payments and redemptions be reinvested in the index by purchasing more bonds.


A mutual fund generates profits in two ways: capital appreciation and dividend disbursements. The growth or decrease in the market price of the asset is referred to as capital appreciation. When calculating the returns provided by a securities, such as an equity fund, both of the above components are important.


However, until recently, just one of these was used to evaluate performance. The Price Return Index (PRI), which served as the benchmark for mutual fund schemes, only reflected the capital appreciation component of index participants. It neglected the dividend payout component of mutual fund schemes. Total Return Index (TRI) has been established to increase transparency and credibility. It considers both capital gains and dividends when calculating returns.


The return of a total return index will always be greater than the return of a price return index for an identical basket of securities. It will be because of the additional dividend payouts. As a result, focusing just on the price return index may exaggerate the amount to which the mutual fund scheme exceeded the benchmark. This is going to be deceptive.


Furthermore, fund companies have received a large number of subscriptions as a result of news of schemes outperforming the benchmark. SEBI's action at this time appears to be timely in order to avoid giving investors the wrong impression.


It is critical for you as an investor to understand the current market pricing scenario and where your investments stand in this mapping. Following the installation of TRI, there have been numerous situations where formerly outperforming funds are suddenly underperforming due to parameter changes, exposing the reality. This will also influence your investing style, whether active or passive.


When PRI was employed as the measuring metric, a large number of funds surpassed their benchmarks, but as their AUM expanded, their return shirked and performance began to decline. In the end, the alpha of such funds began to decline, lowering overall returns.


Also Read | Portfolio Optimization and Asset Allocation Strategies to Maximize Returns




The total return method is a completely different idea. It's a well-known retirement investment technique. The total return or income strategy seeks to increase the income of the investor.  


To create constant income, investors and fund managers who follow the total return strategy invest in high dividend-yielding stocks and fixed-income instruments such as bonds. It is an excellent retirement income investing strategy since it focuses on capital preservation and future capital growth.


Using the Total Return Index (TRI) instead of the Price Return Index (PRI) can have an impact on investors' future investment plans. Especially when it comes to transitioning from active to passive investing. Over the long term, a considerable number of actively managed mutual funds have outperformed benchmark indices.


The TR index allows retail investors to compare their returns on mutual fund investments to the performance of a fund manager using indices such as the S&P 500. Using the TR index to compare the success of various investment possibilities provides a more precise assessment of return on investment.


Using the total return index instead of the price return index will have a substantial impact on an investor's long-term strategy. They can more properly assess the difference in performance using TRI than the price return index.


However, as their asset under management rose, the degree of excess return or alpha began to diminish. If your fund outperforms the Price Return Index but underperforms the Total Return Index for 3 to 5 years, it is time to do a thorough performance assessment.


Finally, if a previously outperforming fund is now underperforming, you must analyze your investing portfolio and eliminate consistently underperforming funds. Make certain that your portfolio is well-balanced and fully matched with your objectives.

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