Know your Price Return versus Total Return Indices

Recently, the S&P BSE SENSEX closed above 30,000 (and 31,000 as of 26th May 2017) for the first time, recording a lifetime high in its 31 years of live history.  Immediately, print and online media were flooded with news articles discussing various milestones of the S&P BSE SENSEX.

There were columns explaining how market participant wealth grew over the past 30 years, comparing different asset classes (equity, fixed income, gold, etc.), with the S&P BSE SENSEX being used as proxy for equities.  What amazed me is that almost all of them used the price return (PR) version of the S&P BSE SENSEX, completely missing out on the cash dividend component.  The version of the S&P BSE SENSEX that is tracked on television or in newspapers is the price return index, which is designed to measure only the capital appreciation (price change) of its constituents.  Like all S&P BSE indices, the S&P BSE SENSEX also has a total return version that measures not just returns from price change, but also returns earned due to cash dividends and their reinvestment, called the S&P BSE SENSEX Total Return (TR).  The cash dividends earned are assumed to be reinvested in the index as of dividend ex-date.

The TR version of S&P BSE SENSEX starts from 19th Aug 1996. The first TR value is exactly same as PR value i.e. 3,281.49 as of 19th Aug 1996. The S&P BSE SENSEX index close value of PR and TR versions as of 26th May 2017 (first time when S&P BSE SENSEX closed above 31,000) is 31,028.21 and 43,778.32 respectively. This shows power of compounding of reinvestment of dividends.

Exhibit 1: S&P BSE SENSEX and S&P BSE SENSEX 50 Index Performance 

Source: Asia Index Pvt. Ltd.  Data from May 29, 2007, to May 26, 2017.  Index performance based on price and total return in INR.  Past performance is no guarantee of future results.  Charts are provided for illustrative purposes and reflect hypothetical historical performance.  The S&P BSE SENSEX and S&P BSE SENSEX 50 were launched on Jan 2, 1986, and Dec 6, 2016, respectively.

Exhibit 2: 10-Year CAGR of the S&P BSE SENSEX and S&P BSE SENSEX 50
S&P BSE SENSEX S&P BSE SENSEX (TR) S&P BSE SENSEX 50 S&P BSE SENSEX 50 TR
7.9% 9.4% 8.5% 10.0%

Source: Asia Index Pvt. Ltd.  Data from May 29, 2007, to May 26, 2017.  Index performance based on price and total return in INR.  Past performance is no guarantee of future results.  Table is provided for illustrative purposes and reflects hypothetical historical performance.  The S&P BSE SENSEX and S&P BSE SENSEX 50 were launched on Jan 2, 1986, and Dec 6, 2016, respectively.

Why Is It Important to Take Note of the TR Index?

Equity investments generally generate returns from two sources—capital appreciation (or price changes) and cash dividends.  In order to have a fair, apples-to-apples comparison, it is important to compare the portfolio returns with the TR version of the index.  For instance, if an investor with a single-stock portfolio compares the returns earned from the portfolio with the returns from the S&P BSE SENSEX (PR), it would be an unfair comparison.  Apart from capital appreciation, the portfolio returns include cash dividends earned.

Exhibit 3: Comparison of a Hypothetical Single-Stock Portfolio and Index
CATEGORY PRICE0

(INR)

PRICE1

(INR)

PRICE RETURN (%) DIVIDEND1

(INR)

DIVIDEND RETURN (%) TOTAL RETURN (%)
Stock A 100 110 10 2 2 12
Index 100 110 10 3 3 13

Source: S&P Dow Jones Indices LLC.  Table is provided for illustrative purposes.

In Exhibit 3, we can see that if we compare stock A’s total return of 12% with the index’s price return of 10%, we would falsely assume that stock A outperformed the index; however, when the same is compared with the index’s total return of 13%, we realize that stock A underperformed.

As TR includes not just PR, but also cash dividends, the TR index will be always be higher than the PR index, because cash dividends can’t be negative.

To conclude, it is absolutely fine to track the PR index on a daily basis.  However, it may be a good idea to use the TR index when one has to measure or compare the returns or performance of asset(s) and scheme(s) with an index, as it is the TR version that would more closely represent what a market participant would take home.

To learn more about TR index calculation, check out Index Basics: Calculating an Index’s Total Return.

The posts on this blog are opinions, not advice. Please read our disclaimers.

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