What is Total Return Index and why is it important?

The Total Return Index (TRI) is a type of stock market index that includes not only capital gains or losses but also dividends or interest payments, if any, from its constituent securities. The Securities and Exchange Board of India in India has directed all fund houses to use TRI as benchmarks for their equity funds.

The index that was earlier used was the Price Return Index or PRI, which factors in only capital appreciation or loss while computing the index’s performance. Dividends or other payouts such as interest income, if any, are not included in the PRI.

TRI is a more accurate benchmark to compare a fund’s performance with because the mutual fund NAV is based on the price of the securities as well as dividends and interest payments.

• Table of contents

1. What is a Total Return Index (TRI)?
2. Advantages of TRI
3. How to calculate TRI
4. Importance of TRI
5. Tips for using TRI

What is a Total Return Index (TRI)?

The Total Return Index (TRI) provides a comprehensive assessment of investment performance for mutual funds. It calculates returns by combining two key elements: capital appreciation and dividend income. Unlike traditional measures that only track price changes, the TRI demonstrates how reinvested dividends contribute to an investor's overall financial gains.

This index assumes that all dividend payments are automatically reinvested into the same investment, creating a more accurate representation of potential earnings. By incorporating both capital appreciation and dividend reinvestment, the TRI offers investors a more complete and realistic picture of an investment's true performance.

The method ensures that the full financial impact of an investment is captured, showing how dividend payments can significantly enhance total returns over time.

Advantages of Total Return Index

The Total Return Index (TRI) offers several significant benefits for investors:

Comprehensive Performance Assessment: While many investors primarily track price changes, the TRI provides a more complete financial picture. By integrating dividend income with price movements, it reveals the full economic potential of an investment, offering a more realistic understanding of actual returns.

Enhanced Investment Comparison: The TRI enables investors to make more precise comparisons between different investment options.

Strategic Long-Term Planning: By presenting a more holistic view of investment performance, the TRI supports more informed long-term financial strategies. It offers a more nuanced method of assessing investment growth compared to traditional price-based measurements.

Versatile Benchmarking Tool: The TRI serves as a robust tool for evaluating various investment vehicles. Investors can use it to analyze the performance of mutual funds, exchange-traded funds (ETFs), and individual stocks, providing a comprehensive framework for investment assessment.

How to Calculate the Total Return Index

Calculating the Total Return Index (TRI)

The Total Return Index calculation involves a systematic approach to measuring investment performance.

Here's a breakdown of the process:

Formula Overview:

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

This calculation can be performed using various currency denominations, providing flexibility for different investment contexts.

Calculation Steps:

Step 1: Calculate Indexed Dividend

First, determine the dividend payment value per index point by dividing the total dividends paid by the index's base capitalization:

Indexed Dividend = Total Dividends Paid ÷ Base Cap Index

Step 2: Adjust Price Return Index

Combine the day's price change and indexed dividend by adding them and dividing by the previous day's price return index:

Adjusted Price Return = (Today's Price Return + Indexed Dividend) ÷ Previous Price Return Index

Step 3: Compute Total Return Index

Apply the adjusted price return to the previous day's Total Return Index:

Total Return Index = Previous Total Return Index * [1 + {(Today's Price Return + Indexed Dividend) ÷ Previous Price Return Index} - 1]

Importance of Total Return Index (TRI)

Consider two indices that have the exact same underlying constituents. In theory, the performance of both the indices should be similar. However, the TRI value is usually higher than the PRI. This is because the TRI includes dividend and interest payouts that are not accounted for in the PRI.

That is what makes TRI a more accurate and representative benchmark for equity mutual funds.

A mutual fund may more easily outperform PRI because the NAV of a mutual fund includes dividend/interest income, which PRI does not. TRI helps investors see more accurately whether the expense ratio and fee they are paying for investing in actively managed mutual funds are being rewarded in the form of benchmark-beating returns.

Tips for using Total Return Index (TRI)

Choose the right benchmark: Always compare a scheme only against its benchmark. For instance, different categories of mutual funds are benchmarked against different TRIs. A large cap fund may be benchmarked against the Nifty 100 TRI, whereas a flexi cap fund may be benchmarked against the S&P BSE 500 TRI. The scheme’s benchmark is mentioned in several scheme-related documents.

Beyond TRI: While TRI is important, always consider factors like expense ratio, the fund manager's track record and your own risk tolerance and objectives before making any investment decisions.

Reinvestment assumption: TRI assumes that all dividends are reinvested back into the scheme. The actual returns will differ if investors plan to withdraw their dividends payouts. A compound interest calculator can help you assess the enhanced growth potential of an investment when dividends are reinvested.

Conclusion

By understanding TRI, you can track the performance of your mutual fund investment against its relevant benchmark with greater clarity, potentially leading to more informed investment decisions.

FAQs

How many TRIs are there in India?

Different market segments and sectors have their own indices. It is important to compare the performance of a mutual fund scheme only against its relevant benchmark index.

Can TRIs help in long-term investing?

Looking at a scheme’s benchmark TRI index can help in making long-term or short-term investing decisions. Total Return Index assumes all dividends and interest payouts are reinvested back in the scheme. Looking at historical returns of the benchmark TRI over long periods can help investors visualize the significant impact of compounding returns on the portfolio over the long term. Do note, however, that past performance does not predict future returns.

What is the difference between TRI and PRI?

TRI includes reinvested dividends, offering a comprehensive measure of total returns. PRI only considers price changes in assets, excluding reinvested income. Thus, TRI reflects both capital gains and income reinvestment, while PRI reflects only capital gains.

What is the difference between TRI and ETF?

TRI and Exchange-Traded Funds or ETF investment serve different purposes. TRI is a benchmark index that tracks the total returns of an index, including dividends and capital gains. An ETF is an investment product that tries to match an index (like a TRI) and can be traded on stock exchanges. ETFs aim to deliver similar returns to their benchmark index.

Total Return Index Meaning

The Total Return Index (TRI) offers a comprehensive evaluation of investment performance for mutual funds. It calculates returns by integrating two critical components: price increases and dividend earnings.

What is the formula for total return index?

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

What is Nifty net total return index?

The Nifty 50 Net Total Return Index tracks the performance of the Nifty 50, assuming that cash dividends and profits from bonus issues are reinvested in the index after deducting applicable withholding and capital gains taxes. It can be said that the Nifty Total Return Index (Nifty TRI) is a modified version of the Nifty 50 Index that takes into account not only the price changes of the underlying stocks but also the dividends paid by these companies.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully. This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.