Poor performance of active mutual funds: Is this a recent development?

We study active equity mutual fund performance from April 2006 to April 2017 to find out if their collective inability to beat the market is a recent development or not.

Published: March 16, 2020 at 1:18 pm

Even a person with a casual interest in mutual funds would agree that interest in index funds and ETFs have increased over the last few years. We have shown several times before that only half or less than half of active funds in any category manage to consistently beat a representative category index. In this article, we answer if active funds have not been able to beat the market only recently or has it been the case earlier too.

In our most recent active vs passive investing study, we focussed on downside protection and return outperformance from April 2006 to March 2020: Do active mutual funds offer downside protection? Or is it a myth?.

In this article, we shall repeat this study from April 2006 to April 2017. Readers may recall, the Sensex and Nifty refused to fall along with Midcap and Smallcap market cap segments after Budget 2018 (Feb).

The most popular indices in India were held up only by a few stocks and this disparity was so much that the return difference of Nifty 50 vs Nifty 50 Equal-weight index was at an all-time high in Dec 2019! This has now started to correct in this market fall: Why this market crash could be healthy after all!

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Thus we restrict our study to April 2017 to ensure this market inhomogeneity is avoided. Large cap funds and some value funds found it hard to beat the Nifty/Sensex from 2018 onwards. The SEBI recategorization rules also kicked in mid-2018. The goal is to find out how active funds managed to perform before these developments.

Another major event that triggered an interest in index funds was the emergence of Nifty Next 50 as a hard-to-beat-index as first reported by us in May 2017. Investors flocked to it see its five-star rating and usual pulled out in fear see its performance from Feb 2018 and three-star rating. As usual, in too-late and out-too earlyAre Indian Investors ready to choose Index mutual funds or ETFs?

Details of the study

We take 258 active mutual funds (regular plans for longer history) from these categories. The benchmarks used are also shown. As argued already, an aggressive hybrid fund is expected to fall lower than a broad market index, hence the use of Nifty 100. Nifty large and midcap 250 is a tougher benchmark than Nifty 200 or Nifty 500. Nifty Midcap 150 is a tougher benchmark than Nifty Smallcap 250. See: Why your small cap mutual fund must beat this benchmark!

Aggressive Hybrid FundNifty 100 TRI
Equity Linked Savings SchemeNifty 100 TRI
Focused FundNifty 100 TRI
Large Cap FundNifty 100 TRI
Value FundNifty 100 TRI
Large & Mid CapNifty Largemidcap 250 TRI
Multi-Cap FundNifty Largemidcap 250 TRI
Mid Cap FundNiftyMidcap150TRI
Small cap FundNiftyMidcap150TRI

We shall define a, return outperformance consistency = no of times fund beat index/tot no returns. For example, say we have 100 13-year return data points and a fund got a return higher than the index in 65 of those instances. Then return outperformance consistency = 65/100 = 65%.

Duration: Ten years

Period: April 2006 to April 2017: Out of 80 funds, 44 funds (55%) beat the index 70% or more out of all 10Y rolling return observations (min 200).

Period: April 2006 to Mar 2020: Out of 83 funds, only 37 (44%) have a return outperformance consistency of >= 70%.

Duration: Seven years

Period: April 2006 to April 2017: Out of 100 funds, 55 funds (55%) beat the index 70% or more out of all 10Y rolling return observations (min 200).

Period: April 2006 to Mar 2020: Out of 87 funds, only 36 (41%) have a return outperformance consistency of >= 70%.

Duration: Five years

Period: April 2006 to April 2017: Out of 100 funds, 48 funds (48%) beat the index 70% or more out of all 10Y rolling return observations (min 200).

Period: April 2006 to Mar 2020: Out of  143 funds, only 62 (43%) have a return outperformance consistency of >= 70%

Duration: Three years

Period: April 2006 to April 2017: Out of 130 funds, 61 funds (47%) beat the index 70% or more out of all 10Y rolling return observations (min 200).

Period: April 2006 to Mar 2020: Out of 145 funds, only 34 (24%) have a return outperformance consistency of >= 70% (this could change once the disparity in Nifty stocks reduces).

In conclusion, clearly there is only a marginal decrease in the active funds that beat the market consistently. It was a little bit more than a coin toss (50%) up to April 2017 and little less than a coin toss-up to March 2020. It is incorrect to assume active fund managers in India are struggling only now. This is yet another compelling reason to consider index investing in India.

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Pattabiraman editor freefincalDr M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over nine years of experience publishing news analysis, research and financial product development. Connect with him via Twitter or Linkedin or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation for promoting unbiased, commission-free investment advice.
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