For investing in equity, a retail investor has two popular choices. One, select and buy the stocks— a DIY approach. Second is to rely on professional fund managers of mutual funds expecting better performance —a smart money approach.
The institutional investors bear a label of ‘smart money’ as they are more experienced, well-trained and well-informed. All the institutional investors charge fund management fees for managing the money in a better way and hence the claim for outperformance is required to justify the fees. Actively managed mutual funds employ professional stock pickers who aim to generate market beating performance. These funds can be categorised as having a higher cost of ownership due to additional overhead expense associated with professional stock analysts.
But is this label of ‘smart money’ justified? Well, to check the validity I decided to dig up the data.
First I checked the large cap universe of mutual funds in India. So, I compared the fund returns with Nifty Next 50 returns. Nifty Next 50 represents large cap companies falling into the list of top 100 other than Nifty 50 companies. Nifty Next 50 return for trailing 1-year, 3-year and 5-year period is 47.73%, 20.06% and 21.84% respectively.
The comparison yielded eye-opener results. For the one-year horizon (year 2017), only one fund scheme out of total 130 schemes in consideration could beat the Nifty Next 50.
It is often contended that one-year returns aren’t a fair snapshot of the long-term performance. Long-term analysis is often seen as the best indicator for judging the fund performance, as it reduces the impact of volatility. Least horizon endorsed is 3 to 5-year investment into the same scheme.
Over the longer span of trailing 3years, the numbers were particularly brutal. For trailing 3-year horizon ending in December 2017 not even a single fund could keep up with Nifty Next 50 returns out of 122 large-cap equity funds with 3-year history. And for the 5-year span, out of 93 large-cap equity funds with 5-year history, only two fund schemes could outperform the index Nifty Next 50 returns over the same horizon.
Small and mid-cap funds
Generally, small and mid-cap equity is not as efficient an asset class as large cap. Hence there is a greater scope of alpha generation for those stocks. So, I even looked at them. And I found a silver lining here.
I found 137 small and mid-cap equity schemes for different AMCs (direct and regular plans) with at least trailing 1-year history, 135 with 2-year history and 59 with trailing 5-year history. I compared the fund performance with Nifty Full Midcap 100 TRI returns. Index returns for 1-year, 3-year and 5-year are 53.43%, 21.03% and 21.24% respectively. For 1-year horizon, 30 out of 137 schemes (21.9%) could outperform the index. And for 2-year horizon, 28 out of 111 (25.23%) schemes could beat the index returns. For trailing 5-year, the picture is even better, with 45 out of 59 (76%) schemes could outperform the index.
One may argue that these results are in the context of a specific index only, but then these indices have their ETFs available in the market and why not compare them as it is an alternative investment avenue for sure. Moreover, Sensex and Nifty have small number of companies. And hence may not be a very suitable benchmark, even if funds choose them.
The data appears to back up a growing global scenario where active stock funds are not worth the cost and index investing is the future in the era of freely and instantly available information. In future, we may see the trend towards direct indexing and index ETFs launched based on smart beta indices.
Nehal Joshipura is faculty member at DSIMS, Mumbai