The focus should be on delivering steady returns over a long period of time that is unlinked to artificial benchmarks and more with the state of the economy, debt market (risk-free) returns and related risks.
The lopsided performance of the Indian benchmark indices over the past 12 months supported by a handful of stocks and low overall positions of FPIs and mutual funds in those stocks would probably suggest that most actively managed funds would have trailed the market indices. In our view, this may be a good wake-up call for the industry to review the relevance of benchmarks in achieving the financial security objectives of households/retail investors.
Lopsided performance supported by a handful of stocks
Only eight of the BSE-30 Index and 17 of the Nifty-50 Index stocks have outperformed their respective benchmark indices. The range of performance of stocks in various benchmark indices is quite large. We see the same pattern repeating across wider benchmarks. Interestingly, the performance of various market indices gets progressively weaker with the ‘breadth’ (number of stocks) of the indices, which is the antithesis of investment management (portfolio diversification to reduce risks).
Handful of stocks performing on ‘macro’ and ‘narrative’
A look at the contribution of various stocks to the performance of the Nifty-50 Index over the past 12 months shows only a handful of stocks have contributed to the performance of the index with most lagging the performance of the index. In our view, the strong performance of most of the outperforming stocks reflects the market’s changed view of the stocks led by weak macro (IT, pharmaceuticals) and ‘narratives’ (consumption stocks, RIL).
The performance of the Indian market in local currency terms has been largely supported by the strong performance of the IT stocks, which in turn have ironically performed as a result of the deterioration in the macro and the resultant sharp depreciation in the INR. The market performance is more muted in USD terms, flat CYTD for the Nifty-50 Index.
Our analysis of the ownership of the outperforming stocks (certain consumer and IT stocks, RIL) over the past four quarters suggests that most funds had had low ownership in such stocks. We clarify that we have looked at the overall ownership of FPIs and MFs in various stocks (holding in a stock as percentage of composite portfolio of FPIs and MFs) and some funds would not even need to own these stocks (large-cap stocks by mid-cap. funds, as an example). Also, certain funds may have had disproportionately large positions in the outperforming large-cap and mid-cap stocks, which could have enabled them to do relatively better.
Kill the benchmarks before the benchmarks…
We have long argued against the use of artificial benchmarks as the basis of the active fund management industry. They serve little purpose and result in disproportionate focus of investors on meeting ‘certain’ relative returns, which at times may not be commensurate with the risk in the market. Instead, the focus should be on delivering steady returns over a long period of time that is not linked to artificial benchmarks and more with the state of the economy, debt market (risk-free) returns and related risks. This will also enable active investors to use value of a stock as the guiding principle for investment in a stock rather than the price (weight) of the stock.
Edited extracts from Kotak Institutional Equities Research report