Here is a strange but true fact about how mutual funds beat the index! It is also the reason why I keep stressing on downside protection. Mutual funds that beat the index consistently find it easier to beat the index when it falls than when it rises! Here are numbers from the Dec 2018 freefincal Equity mutual fund screener
As regular users may know, the screener uses three metrics to analyze funds. (1) how frequently a fund beat the index also known as rolling return outperformance consistency. (2) How frequently a fund protected the downside that is fall less than the index (when the index fell) also known as downside protection consistency. (3) How frequently a fund performed better than the index when the index moved up, also known as upside performance consistency.
One might think downside protection without return outperformance is of no use. Yes, this is true. However, many investors also assume that upside performance is important or even essential for a fund to beat the index. This is wrong! As we will see below, downside protection is crucial and upside performance almost optional!
How mutual funds beat the index: The steps
- The screener file has 233 funds.
- Out of these, over 5 years, 112 funds have beat the index with >= 70% of the time.
- From these 112, If we count funds with downside protection consistency of >= 70% over 5 years, we get 87 funds.
- From the 112, If we count funds with upside performance consistency of >= 70% over 5 years, we get only 28!!
So let us abbreviate this information in the following way (five years):
233 –> 112 (return outperformance 5Y). Downside (5Y) = 87/112. Upside (5Y) = 28/112
If we repeat the process over four years, we get
233 –> 119 (return outperformance 4Y). Downside (4Y) = 91/119. Upside (4Y) = 31/119
Finally over three years, we have
233 –> 103 (return outperformance 3Y). Downside (3Y) = 66/103. Upside (3Y) = 18/103
What do these results mean?
- It is easier for a fund manager to beat the index by protecting the downside that is making sure the fund falls less than the index than performing better than the index when the index is moving up.
- There are several corollaries that one can show: 37 out of 233 funds have 70% or more upside consistency. Out of these, 28 also have 70% or more return outperfromance.
- Although 158/233 funds have 70%+ downside protection, only 87 have consistently (70%+) beat the index. So upside performance (although in of itself rarer) seems to have a better chance of outperfromance than downside protection
- Only 25/233 funds have 70%-plus upside and downside performance over 5 years. Out of these 21 funds have 100% return outpeformance, 3 funds with 82%, 63% and 58% return outperformance. Two funds, DSP Top 100 and Can Reb Equity Diversified have 0% return outperformance!!
- Only 22/233 funds have 70%-plus upside and downside performance over 4 and 5 years
- Only 14/233 funds have 70%-plus upside and downside performance over 3, 4 and 5 years. From these 14, only the following 11 funds have return outperfromance of 70%-plus over 3,4,5 years!
|EQ-L&MC||Nifty Largemidcap 250 TRI||Principal Emerging Bluechip Fund – Direct Plan – Growth Option|
|EQ-VAL||Nifty Largemidcap 250 TRI||Invesco India Contra Fund – Direct Plan – Growth|
|EQ-VAL||Nifty Largemidcap 250 TRI||Tata Equity P/E Fund -Direct Plan Growth|
|HY-AH||Nifty 100 TRI||Principal Hybrid Equity Fund- Direct Plan – Growth Option|
|HY-AH||Nifty 100 TRI||Tata Retirement Savings Fund Moderate -Direct Plan Growth|
|EQ-MLC||Nifty Largemidcap 250 TRI||Aditya Birla Sun Life Equity Fund – Direct Plan|
|EQ-ELSS||Nifty Largemidcap 250 TRI||Aditya Birla Sun Life Tax Relief ’96 – Growth – Direct Plan|
|EQ-LC||Nifty 100 TRI||Reliance Large Cap Fund – Direct Plan Growth Plan – Growth Option|
|EQ-LC||Nifty 100 TRI||Motilal Oswal Focused 25 Fund – Direct Plan|
|EQ-L&MC||Nifty Largemidcap 250 TRI||Aditya Birla Sun Life Equity Advantage Fund – Growth – Direct Plan|
|EQ-MLC||Nifty Largemidcap 250 TRI||Principal Multi Cap Growth Fund-Direct Plan – Growth Option|
So what you make out of all this?
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