Active Large Cap MFs recover along with equal-weight indices

Published: December 18, 2020 at 10:25 am

Readers may recall, a year ago (Dec 21 2019), we showed that the return difference of Nifty 50 vs Nifty 50 Equal-weight index at an all-time high. This essentially means that only the top few stocks of Nifty were holding the market up. This was apparent from late 2017 to just before the 2020 crash: Nifty moved up while other indices like Nifty Next 50, Nifty Midcap 150 and Nifty Smallcap 250 moved down. In what can only be a relief to active fund managers and their investors, this imbalance has now corrected significantly.

Even as early as May 2020, we reported that after the market crash, 80% of active large cap funds outperform Nifty, Nifty 100. This development is now on firmer ground, although the degree of outperformance is not as high as 80%. To see what we mean, consider this table of trailing returns.

BenchmarkNIFTY 50 – TRINIFTY 50 Equal Weight Index – TRINIFTY 100 – TRINIFTY 100 Equal Weight Index – TRI
1 Year14.220.714.317.6
2 Years13.711.312.910.2
3 Years11.36.210.24.6
4 Years15.410.714.910.5
5 Years13.310.613.110.4

Notice how both the Nifty 50 and NIfty 100 equal weight indices have only managed to outperform the Nifty 50 and Nifty 100 in the last one year. In the Nifty 50 or Nifty 100, the top ten stocks would account for the bulk of the weight (50-60%) while in an equal-weight index, all stocks have an equal say.

It is only in the last year the bottom stocks of the Nifty 50 and Nifty 100 have been able to move up. This can also be seen from the one-year rolling return difference between the above four indices.

One-year rolling return difference between Nifty 50 Equal Weight TRI and Nifty 50 TRI
One-year rolling return difference between Nifty 50 Equal-Weight TRI and Nifty 50 TRI
One-year rolling return difference between Nifty 100 Equal Weight TRI and Nifty 100 TRI
One-year rolling return difference between Nifty 100 Equal-Weight TRI and Nifty 100 TRI

Notice the gradual increase in the (Equal-weight index return minus index return) over the last couple of year hastened by the market crash and subsequent rally (white circles). For the Nifty 50 pair, the difference was -10.5% in March 2020 and is now about +5.5%.


This means if you looked at the trailing one-year return of Nifty 50 Equal-weight in March 2020 it would have been 10.5% lower than Nifty 50. Today is it 5.5% higher!

Active Large Cap Fund Performance

Anyone who is used to studying fund returns in a portal like Value Research would tell you, a year back or two years ago, the top funds if you looked at the last one year return were Nifty or Sensex funds/ETFs. A few years before, they were typically backbenchers. Today, you will have to scroll down a bit to get to the first Nifty/Sensex index fund.

  • If we consider last five years trailing returns, only 5 out of 27 active large caps did better than the Nifty 50 TRI.
  • Last four years, again 5/27 outperformed.
  • Last three years, just 2/28
  • Last two years, it has shot back up to 11/28
  • Last one year 11/29.

The correction in market imbalance is a key factor behind the resurgence in active large cap fund performance. Notice that that interest in index investing increased during a time when the active large cap fund performance was obvious. Will these index ‘fans’ stay put when more active funds become “five-star rated”? Only time will tell.

  • Between Dec 2015 to Dec 2016: 25 out of 27 large caps outdid the Nifty 50 TRI
  • Dec 2017 to Dec 2016: It dropped to 15 out of 27 as the imbalance set in
  • Dec 2018 to Dec 2017: only one outperformed out of 28.
  • Dec 2019 to Dec 2018: It shot back up to 13 out of 28.
  • Dec 2019 to Dec 2020: 11 out of 29 large caps outdid the Nifty 50 TRI

What do these results mean? What should investors Do?

The removal of the market imbalance (even if its temporary) is good news not just for active large cap fund managers and their investors. It is good news for index investors too as the dependence on only a few stocks have gone done. See for example:  Do index fund returns depend upon just a few stocks (Concentration risk)?

If you had switched from an active large cap fund to an index fund, stay put. Finding and staying invested in a large cap fund that would be at the Nifty or Sensex is still a coin-toss (50-50) today, and it was a coin-toss even before the market imbalance set in. See: Active mutual funds struggle to beat Nifty 50 for the last seven years! And Poor performance of active mutual funds: Is this a recent development?

There will always be phases like this with a resurgence in active funds. There will always be some funds that beat the market. The point to note is, it is impossible to find an active fund that will beat the index all the time and after you start investing in it.

This should be your only reason to choose the index: It is expensive to chase after returns; You can invest peacefully with an index fund without worrying about underperformance and high fees. If you have a sense of missing out when you see a handful of active funds outperform the market, then index funds are not for you. Active funds are also not for you.

Some index investors tend to get angry or confused when they see data such as this. This often stems from a lack of a plan and conviction. Just as it is incorrect of AMCs to market the efficacy of active funds blindly; it is equally incorrect to blindly market the ability of index funds to beat active funds.

That active large cap funds have been able to fare better in 2020 is a fact. Whether that is relevant to a person’s portfolio or not will depend on their perspective and strategy – assuming they have one.

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