Actively managed funds have underperformed benchmarks but this could soon change

In the fund management industry, there is one big difference between developed markets like USA and emerging markets like India: a clear shift from actively managed funds to passively managed ones like ETFs. While low TER is the key reason for significant popularity of ETFs in developed markets, other factors like better flow of information and difficulty in finding under researched stocks too have contributed to the growth of ETFs.

If there were no outperformance in actively managed funds, investors would rather settle for ETFs at lower expenses. However, in India, there are a vast number of listed stocks, of which many are under-researched giving fund managers the scope to generate the out-performance over benchmark, i.e. alpha. ETFs in India are yet to catch up with their actively managed peers. We need to acknowledge here that alpha generated by fund managers have made actively managed funds popular in India.

However, over the last one year, things have changed for actively managed funds in India. The growth in the market, or to be precise the indexes, has been concentrated in a few large cap stocks. This has led to actively managed funds underperforming their respective benchmarks. As per portfolio management principles, a portfolio should not be concentrated in a few stocks, and SEBI rules limit maximum exposure to individual stocks. As long as the benchmark growth is driven by a few bid constituents, this situation will continue.

Now let us take a closer look at the numbers.

Taking AMFI’s basket of 28 large cap funds, average return over last one year till 31 May ’19 is 7.65% in regular plan and 8.77% in direct plan. These funds follow various benchmarks; mostly it is the Nifty 50 total return index (TRI), whereas some follow BSE 100 TRI or Nifty 100 TRI. The average return from the benchmark of all these funds is 11.28% over last one year. This under-performance has pulled down the performance over last 3 years as well; it is 12.17% and 13.39% in regular and direct plan respectively against the benchmark return of 14.97%.

This is reflected in the five-year period as well. It is 11.76% and 12.94% in regular and direct plans against the benchmark average of 12.02%. The alpha of actively managed funds is visible over the last 10 years: it is 12.3% in regular plan against 12.05% of benchmark.

For multi cap funds, the range of stocks is wider. Currently, there are 29 multi cap funds. Average return over last one year till 31 May ’19 is 4.56% in regular and 5.62% in direct, against 6.9% of benchmark.  The funds follow benchmarks like Nifty 500 TRI or BSE 500 TRI or Nifty 200 TRI. Funds have under-performed over 3 years as well – it is 12.6% and 13.65% against 14.41%. However, multi cap funds have beaten benchmarks over 5-year horizon; it is 12.93% and 13.92% against 12.41% of benchmark. There is a positive alpha over 10 years; it is 13.77% in regular plan over 12.24% of benchmark. Over the last year or so, ETFs have gained traction due to the lack of alpha. The AUM of equity ETFs is Rs 1.31 lakh crore as on 30 April 2019, up from Rs 77,501 crore as on 30 April 2018.

The reason of under-performance is the concentrated growth in the benchmark driven by a few large cap stocks.

The point is proven if we look at the category of small cap funds. Returns of small cap funds over the last one year were -8.21% and -7.23% in regular and direct plans, respectively. The benchmarks followed by funds include Nifty Small Cap TRI and BSE Small Cap 250 TRI. The average benchmark return over last one year is -14.14% i.e. funds have lost less than the market. Over the last three years, funds have delivered between 10.88% and 11.93% against the benchmark return of 9.55%. The outperformance is even more over longer horizons. Over five years it is 15.56% and 16.53% against 9.73%. Over a ten-year horizon, fund performance is 15.51% in regular plan against benchmark 10.52%.

To conclude, over the last year or two, comparison with benchmark has moved from PRI to TRI, growth in indexes is concentrated in a few large cap stocks whereas funds have to run a diversified portfolio. As and when market growth becomes broader, majority of funds would start generating alpha.      


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