By Ashley Coutinho
The alpha delivered by the mutual fund industry has declined in the past 15 years and active funds are struggling to beat their underlying benchmarks. Nearly 80% of the industry’s active assets under management (AUM) have outperformed the benchmarks over a 10-year period. However, only 40% have done so over three- and five-year periods.
The findings are part of a study done by Kotak Institutional Equities covering nearly 200 active equity funds. “There are nearly 20-25% of active equity AUM that are bottom-quartile and have underperformed in the past 3-5 years. This should justifiably convert into low-cost passive instruments like index funds or ETFs over the next 5-10 years,” said the report.
Large- & mid-cap and small-cap funds have performed relatively better in outperforming the benchmarks. Bigger categories such as large-cap and flexi-cap have seen sharper declines in outperforming AUM. Value funds have made a strong comeback in the recent past, with about 75% of AUM outperforming compared with just 10% as of March 2020.
The AUM of passive funds have grown to Rs 3.3 trillion, which is about 15% of equity AUM (including hybrid) from about 3% as of March 2016, led by increasing allocation by the EPFO into select ETF funds. However, retail participation is yet to play out in a big way, despite increased awareness, strong markets and the proliferation of investing apps that work on a commission-free model.
In developed markets, the underperformance of active fund managers and the shift to passive funds have coincided with the institutionalisation of market ownership, increasingly faster data dissemination, broader and cheaper information access, as well as the regulatory push for greater transparency and lower costs.
“Financial markets are increasingly witnessing faster data dissemination, broader and cheaper information access, and regulators’ push for greater transparency and lower costs. These trends will compress return opportunities for traditional active managers,” the report said. However, emerging markets, such as India, still offer more potential for active managers to deliver alpha and to also bring professional investing to a larger set of participants.
Truly active funds, which take differentiated positions versus the indices, distinctly reward their investors, according to the Kotak study. Top-quartile active funds delivered nearly 100-400 bps net excess returns over the bottom-quartile funds across three-, five- and 10-year time frames. The excess returns of ‘highly active’ funds come in at relatively lower expense ratios as well.
“Markets have a place for both active and passive investment approaches. Fund managers who are truly active and take long-term calls are able to deliver excess returns and justify their fees,” the report observed.