Mutual Funds: Choose large-cap funds wisely, some now generate lower returns than BSE 100 index

New Delhi | March 13, 2019 2:47 AM

Since most investors are usually busy pursuing their professional commitments, mutual funds have emerged as a favourite investment vehicle in India.

mutual funs, equity mutual fundsBetween December 2013 and 2018, AUMs of equity mutual funds increased by more than 200%.

By Rohan Chinchwadkar & Shwetabh Sameer

If you watch television, listen to the radio or stream cricket matches online regularly, it is almost impossible to have missed the investment mantra ‘Mutual funds sahi hai’. The advertising campaign by the asset management industry gathered steam in the last two years as an increasing number of investors turned to financial markets to park their money.
As the government’s JAM trinity (Jan Dhan-Aadhaar-Mobile) connects more and more people to the mainstream financial system, a larger part of India’s savings is expected to flow into a variety of financial instruments.

Rise in AUM

Since most investors are usually busy pursuing their professional commitments, mutual funds have emerged as a favourite investment vehicle in India. In spite of a 5% correction in equity markets since August 2018, mutual fund assets under management (AUMs) remained above Rs 23 lakh crore by the end of February 2019.

Between December 2013 and 2018, AUMs of equity mutual funds increased by more than 200%. Within equity mutual funds, large cap funds have attracted substantial amount of money since they are usually considered the safest. Hence, it would be useful to analyse how large cap mutual funds have performed over the last few years.

According to Morningstar, 123 fund schemes qualified to be categorised as large cap funds on December 31, 2013, based on their stock portfolios. It is important to note that five years later, only 93 of these 123 schemes existed as independent entities, either due to mergers with other schemes or due to scheme closure. Since demonetisation, AUMs of this group of funds have increased by more than `1 lakh crore and the average size of fund has almost doubled to Rs 2,915 crore.

Performance of large cap funds

We calculate the performance of these large cap funds at the end of every month between December 2013 and 2018 using the ‘three-year rolling return’ (the return accrued to an investor holding the fund in her portfolio for three years). However, measuring pure return does not give us a complete picture of performance.

Since fund managers charge fees for active management (typically 1.5-2%), they are expected to generate returns higher than that of a passive benchmark. The return which active fund managers generate over and above a passive risk-matched benchmark is called ‘alpha’. Thus, we look at the ‘three-year rolling alpha’ of large cap funds over the last five years.

The picture looks grim when we look at the past performance of large cap funds. Large cap alpha (return over and above that of a BSE 100 exchange-traded fund) is now negative and touched an all-time low of -1.86% in December 2018. A closer look reveals that large cap alpha peaked at around 6% in late 2016 and has been declining ever since.

Not only that, less than 20% of large cap funds now generate a higher return than that of the passive BSE 100 index. In late 2016, more than 90% of the funds were outperforming the benchmark. To add to that, returns over a shorter horizon exhibit much worse performance. One-year rolling alpha of large cap funds touched a low of -7% in December 2018 and has been declining steadily since 2015.

Choose wisely

What does all this mean for mutual fund investors? For one, do not invest in large cap mutual funds blindly. It has become critical to select the right large cap funds, ones which are expected to generate a sustainable alpha in the future. Investors would do well to use holistic forward-looking frameworks to choose winners.

It is important for mutual fund investors to review their portfolios at regular intervals (at least once every year) to ensure that they drop the laggards and include the expected stars. All in all, it might be time to modify the advertised investment mantra to ‘Kuch mutual funds sahi hai’.

Rohan Chinchwadkar is assistant professor of finance at IIM Trichy and Shwetabh Sameer is senior analyst at Morningstar.

Get live Stock Prices from BSE, NSE, US Market and latest NAV, portfolio of Mutual Funds, Check out latest IPO News, Best Performing IPOs, calculate your tax by Income Tax Calculator, know market’s Top Gainers, Top Losers & Best Equity Funds. Like us on Facebook and follow us on Twitter.

Financial Express is now on Telegram. Click here to join our channel and stay updated with the latest Biz news and updates.

Next Stories
1After the market rally: Get ready for next phase of investment journey
2Your Queries (Income Tax): Long-term capital loss on NCD can be set off against long-term capital gain
3Your Money: Follow the 12:80:80 asset allocation approach