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Did Active Mutual Funds Beat Index Mutual Fund? One Year Horizon Status Check

Assume you have decided to put money in equity mutual funds. This begets another question: be a DIYer or go through a professional (RIA, distributor whatever)?

Any choice one makes, this will lead to another dilemma – how do you or the professional choose that killer fund (manager) which will deliver the significant excess ROI over your “safe” fixed income investments. Once could have taken in easy and gone for Index funds. But these never come into picture for most people. High decibel marketing for active funds keeps index funds in the shadows.

Circling back to question of utmost importance – how to shortlist, say 5 “best” equity funds to deploy the capital? One will, as most people do look to the best free advisor in the world – google for answers. This will lead you to some mutual fund rating websites. Apply some easily understandable filters and one will have shortlist of “best” performing funds. But some with higher analytical bent of mind will go further – they will look for consistency in performance over long period and then shortlist the funds. Admittedly, I also did the same when I started investing my funds nearly 10 years ago. But all this exercise still offers no guarantee that you will land up with a fund which will give similar performance in future.

Why?

The key issue which comes up here is – overlapping data. If a fund has done well in 10 year period, chances are it may find place in 5 or 3 of 1 year period too, and thus distort findings.

So, for a start, we will just look at 1 year data. Let’s frame some hypothesis:

Criteria for selection:

-          All Large cap funds, excluding index or ETF for April 2020 – March 2021

-          Minimum / maximum AUM: None whatsoever. We don’t want to be biased towards small or large funds

-          Top 5 funds, basis only one criterion – “Returns” shortlisted. We are keeping it simple!!! No complex risk parameters like Sharpe ratio, Treynor ratio etc

-          Funds allocated in equal proportion to all 5 funds. No bias again!!!

-          Same fund allocated to the sole Nifty 100 fund available for the period

-          At least 10% alpha subject to minimum of 100 bps required as that can be considered as statistically significant

-          Performance compared for active portfolio with index portfolio for April 2021 – March 2022

Which five large cap funds make it to our shortlist basis outsized performance in April 2020 – March 2021 period?

-          Quant Focussed fund

-          Franklin India Bluechip Fund

-          SBI Bluechip Fund

-          Kotak Bluechip Fund

-          ABSL Frontline Equity Fund

So we put our money (hypothetically) in equal proportion in these funds and compare performance for the period April 2021 – March 2022 with the sole Nifty 100 index fund available (see, the MF universe is also conspiring with us to keep things simple). Mind you – we are comparing with “index fund” and not index!!! So cost of investing in index is already factored in.

The Nifty 100 index fund delivered point to point ROI of 17.80%. How did our active funds fare?

-          Two delivered ROI better than Nifty 100 index fund and rest 3 faltered!!! Essentially, 60% of best performing funds of “last year” failed to beat the humble index fund in subsequent year.

-          What about equal weight portfolio of 5 active funds? The weighted average ROI of active fund portfolio comes to 16.65%. That’s good 1.15% BELOW Nifty 100 Index fund ROI for the period!!! While as per our criterion of active fund performance, we were looking at active fund portfolio ROI of 19.58%.

We have it again – simply looking at numbers the appropriate way gives us very different opinion about active versus passive fund debate in Indian context. Which way one takes as an investor is matter of individual decision making!!!

Credit where due: Data source is “valueresearchonline.com”

Post script: Some will say looking at just 1 year performance is not done. Some funds may underperform the index for few years but still deliver index beating performance in longer term. To those, my submission is – soon I will put up numbers for 10 year basis same criteria as above. Or you can check out the same yourself too!!!

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