Why Do Indian Equity Mutual Funds Always Disappoint Investors?
(Updates 10Apr2024, 11Oct2023 and 12Apr2023 are available at the end of the article)
Actively managed equity mutual funds in India are one of the worst performing against their respective benchmarks; as compared to the performance of other major countries across the globe.
You take any asset class, be it stocks or bonds or gold, mutual funds not only in India but the world over, underperform their benchmark indices by a wide margin.
I've highlighted the underperformance of Indian equity funds in the past. You can check my previous blogs mentioned below.
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What Experts Say
Several research studies done over 55 years have found mutual funds underperforming well diversified benchmark indices. The first comprehensive study of mutual funds' performance was done by Michael C. Jensen covering 115 mutual funds over 10 years from 1955 to 1964.
As per Jensen's study, only 26 of the 115 funds (23 percent of total) outperformed the market. On average, the underperformance of mutual funds for ten years was 15 percent. Absent loading charges (commissions paid by investors to mutual fund brokers), the loss of wealth was 8.9 percent with 43 of the 115 funds (37 percent) outperforming the market.
Institutional and professional money managers tend to follow the crowd and hold the stocks that are part of the major indices, like, Dow Jones, S&P 500, Nasdaq or FTSE 100. Their portfolios look like any passive portfolio tracking a benchmark index (known as index hugging).
Most of the time, they tend to chase stocks that are hot favourites currently. They often have high portfolio turnover, churning the portfolio of stocks too often. (see post script)
After fund fees, these money managers are unable to beat the market.
SPIVA Reports
S&P Dow Jones Indices for over 20 years has done pioneering work on documenting the performance of actively managed mutual funds versus the benchmark indices. Their research covers most markets globally. These reports are known as SPIVA (S&P Indices Versus Active Funds).
The following three tables highlight the performance of equity mutual funds in India as pointed out by SPIVA reports. As per the reports, more than 80 percent of equity funds fail to beat the returns of their benchmark indices over most of the time periods.
I've analysed how Indian equity funds performed over a period of five years from 2018 to 2022 -- covering large-cap, ELSS (equity linked savings schemes) and mid-/small-cap funds -- for one-, three-, five- and 10-year periods.
Data in these tables are based on absolute returns (not on risk-adjusted returns). Latest data available from SPIVA are as of 30Jun2022 (report for 31Dec2022 may come out in Apr2023).
Table 1: Indian equity large-cap funds' underperformance:
As shown above, as of 30Jun2022, 91 percent of large-cap funds underperformed, on a one-year basis, the benchmark index, namely BSE 100. On a 10-year basis, the performance of active funds looks slightly better with 67 percent of large-cap funds underperforming as on 30Jun2022.The underperformance of active funds is similar for other time periods, between 2018 and 2021. Only in COVID-19 outbreak year (30Jun2020), 52 percent active funds outperformed the BSE 100 on one-year returns basis.
Table 2: Indian equity ELSS funds' underperformance:
As compared to large-cap funds, ELSS funds seemed to have done better than BSE 200 index for periods between 2018 and 2021 when compared on a 10-year returns basis. But the overall underperformance of ELSS is similar to that of large-cap funds for 1-year, 3-year and 5-years returns in all time periods between Jun2018 and Jun2022.
Table 3: Indian equity Mid-/Small-cap funds' performance:
The performance of mid- and small-cap funds looks interesting. On a one-year returns basis, as on 30Jun2022, 30Jun2020 and 30Jun2019, majority of these funds, as shown in Table 3 above, have done better than their benchmark index, that is, BSE 400 MidSmallCap index.
For example, as on 30Jun2019, 81 percent of mid-/small-cap funds outperformed their benchmark index on a one-year basis; and 73 percent of funds outperformed the index on a 5-year basis.
On a 10-year basis, majority of these funds performed better than their benchmark index between Jun2019 and Jun2022.
Investment Implications
So, making money by mutual funds or asset management companies (AMCs) based on good performance is tough; so, they resort to asset-gathering abandoning asset management altogether -- asset gathering seems to be the only way left for them in order to make money for themselves, if not for unitholders of mutual funds.
You may have observed that AMCs in recent years have been floating a plethora of passive funds (index funds and ETFs or exchange traded funds), most of which are unsuitable for a common investor. (see post script)
Fund managers are afraid of holding off-beat stocks that are neglected by markets. They are most of the time chasing relative performance -- comparing themselves with other fund managers' performance.
If you observe the portfolios of equity mutual funds in India, you may have noticed some funds hold more than 70 to 80 stocks in their portfolios. In addition, these schemes tend to hold a large number of stocks with less than two percent of their total assets of the scheme in a single stock. (see post script)
To be fair to them, I would add that Indian stock markets lack depth and liquidity as compared to the US or European markets. As such, to avoid liquidity risk, some large funds tend to hold a large number of stocks. Naturally, these schemes suffer from over-diversification resulting in lower returns for investors / unitholders.
Indian mutual funds in recent years have been facing competition from alternative investment funds (AIFs) and portfolio management services (PMS).
And, Indians seem to be investing their surplus more in foreign funds, stocks and other asset classes (within the USD 250,000 limit permitted in India under the LRS or Liberalised Remittance Scheme).
All the above are negative for shareholders of listed AMCs in India, because competition within and outside India has been working against the mutual fund industry (now, there are five listed AMCs in India). And the same can be said overall for the unitholders of active mutual funds managed by these AMCs.
Put differently: the chances of actively managed funds beating the market are low to moderate and the chances of getting decent returns from stocks of listed AMCs is tough going forward.
But passive flows, via monthly systematic investment plans (SIPs), Employees Provident Fund Organisation (EPFO) and insurance companies, come automatically -- which will continue to be a positive for the mutual funds.
Summing Up
That equity mutual funds in India fail to beat market returns is a given. That doesn't mean no mutual fund scheme can beat the market. There are always some exceptional money managers -- but it's hard for unitholders to identify them in advance.
Moreover, it's difficult to find fund managers who can beat the market consistently over longer periods, say, 10 to 20 or even 30 years. Here, I'm not even talking about manager churn -- meaning money managers often jump from one mutual fund company to another. So, tracking such managers and funds is arduous.
Most investors will be better off holding passive funds (that is, index and / or exchange traded funds or ETFs) rather than active mutual funds. If you're able to identify well-performing active mid- and small-cap funds, you may pick up these funds based on your risk appetite and investment goals; though small- and mid-cap funds entail greater risks.
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Update 10Apr2024:
S&P Dow Jones Indices (part of S&P Global) on 28Mar2024 released a new India SPIVA Report on Indian mutual funds, with data as at the end of 31Dec2023. The new data (all data presented here are based on absolute return basis, not on risk-adjusted return basis) are presented in the following updated tables >
India's large-cap and mid/small cap funds continue their underperformance as on 31Dec2023 also.
Compared to 30Jun2023 data, on a 1-year basis, large cap funds' performance improved with only 52% (83% underperformance as on 30Jun2023) of active funds underperforming the benchmark BSE 100 index.
However, on a 3-, 5- and 10-year basis, active funds' gross underperformance continues with 88%, 86% and 62% active funds underperforming respectively versus the benchmark.
A pleasant surprise is only 30% of ELSS funds underperformed the benchmark index on a 1-year basis, though more than 50% of active ELSS funds underperformed on a 3-, 5- and 10-year basis (put differently, 70% of ELSS funds outperformed their benchmark on a 1-year basis, which is quite impressive).
Please check the data for large-cap, ELSS and Mid/Small-cap funds in the updated charts below >
Update 11Oct2023:
S&P Dow Jones Indices (part of S&P Global) on 10Oct2023 released a new India SPIVA Report on Indian mutual funds, with data as at the end of 30Jun2023. The new data (all data presented here are based on absolute return basis, not on risk-adjusted return basis) are presented in the following updated tables >
India's large-cap and mid/small cap funds continue their underperformance as on 30Jun2023 also.
On a 1-year basis, 83 percent of large-cap funds underperformed the benchmark index, i.e., BSE 100; though on a 10-year basis, only 61 percent of funds underperformed the benchmark.
When it comes to mid/small cap funds, 78 percent of funds underperformed the benchmark index, i.e., BSE 400 MidSmallCap index; but on a 5-year basis, their performance looks better with only 38 percent of funds underperforming the benchmark.
What is peculiar here is mid- and small-cap stocks have done well in Apr-Jun2023 quarter; but the underperformance of mid- and small-cap mutual funds, on a 1-year basis, is very high at 78 percent -- which is the highest in the past three years.
The stand-out performance of this SPIVA report as on 30Jun2023 is that of ELSS funds. On a 1-year basis, only 34 percent of ELSS fund underperformed the benchmark index -- to put differently, 66 percent of ELSS funds outperformed the benchmark index on a 1-year basis.
Update 12Apr2023:
S&P Dow Jones Indices (part of S&P Global) on 11Apr2023 released a new India SPIVA Report on Indian mutual funds, with data as at the end of 31Dec2022. The new data (all data presented here are based on absolute return basis, not on risk-adjusted return basis) are presented in the following updated tables >
Key highlights as of 31Dec2022:
> majority of Indian equity mutual funds continue to fail the benchmark indices
> bond mutual funds fared the best, with only 45 percent of funds underperforming the indices
> among all the equity categories, Mid-/Small-Cap equity funds fared the best by far in the long run, with exactly 50 percent of them beating the benchmark index over the 10-year period
P.S. 23Feb2023:
1) Large holdings by mutual funds: For example, Kotak Balanced Advantage Fund, managed by Harish Krishnan, Abhishek Bisen and Hiten Shah, has got 100 stocks (excluding debt securities) in its portfolio as on 31Jan2023 -- of which, 79 stocks have individual stakes less than one percent of total assets. It's unfathomable why these fund managers hold such a large number of stocks in their portfolios. There are several such equity oriented funds.
2) ETF Assets: ETF assets (other than gold ETFs) swelled from Rs 28,800 crore in Dec.2016 to Rs 497,000 crore in Dec.2022 -- a staggering annual growth rate of 60.7 percent in six years!
3) It is fair to say fund managers are bedeviled by large inflows and outflows from unitholders -- so, in order to manage the flows, they need to do some sell trades and buy trades (resulting in portfolio turnover) -- fund managers have no control over such involuntary trades.
References:
'The School of Athens' by Raphael - Wikimedia Commons
Capital Ideas: The Improbable Origins of Modern Wall Street by Peter L Bernstein
SPIVA Library (S&P Global) - region-wise (India included) / mutual fund underperformance - SPIVA reports
India SPIVA report - as on 30Jun2022 PDF (released on 12Oct2022) -- India SPIVA as on 31Dec2021 PDF (released on 13Apr2022) -- mutual fund underperformance
SPIVA report BSE (available only till mid-year 2021) - year-end 2021 PDF report -- India SPIVA scorecards are available only since Dec.2013.
SPIVA World Report 30Jun2022
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Disclosure: I've vested interested
in Indian stocks and other investments. It's safe to assume I've interest in the financial instruments / products discussed, if
any.
Disclaimer: The analysis and
opinion provided here are only for information purposes and should not be construed
as investment advice. Investors should consult their own financial advisers
before making any investments. The author is a CFA Charterholder with a vested
interest in financial markets.
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