If you ask Indian investors what returns would make them happy, most would quote a figure between 10-20%, with around 15% being the sweet spot for many that I know of. Is that a good number, especially for the equity markets? Should you be happy if your equity investments in stocks or mutual funds gave you that much returns in any particular year?
Let’s say that 15% is your idea of “good returns”. Now, if you get 15% in a year that the markets have crashed & Nifty-50 has given 0% returns – then that’s great, you should be very happy. But what if you get 15% in a year that the Nifty-50 has returned 25%? Does the 15% now qualify as “good returns”?
The idea of “good returns” for any investment is often a fixed number for many investors – but the reality is that whether the returns have actually been good or bad can only be determined relatively. Most fund managers (either in mutual funds or Portfolio Management Services) have a defined objective to beat a particular index, and as such a common performance measure is to compare the total returns of the fund against that of its benchmark.
As investors, by seeing the excess returns over the benchmark, you can see how much value the manager adds & analyse if they are worth the additional costs.
For example, if your mutual fund is benchmarked against the Sensex-30, compare the relative performance of the fund & the index over the same time period (e.g. 1-year) . If the Sensex-30 has returned 5%, and your fund has returned more than that net of costs, then that’s good – and if the fund has returned less than 5%, then it’s said to have underperformed the index.
The SPIVA® Scorecards
The S&P Dow Jones Indices maintains a scorecard that tracks the performance of such actively managed mutual funds in India. Called the S&P Indices Versus Active (SPIVA) India Scorecard, it provides a semiannual update on the performance of “actively managed Indian mutual funds compared with S&P DJI indices in their respective categories.”
The most recent SPIVA® report for the calendar-year ending 2018 came out in the first week of April, and the results are quite interesting. More than 91% Large-Cap and 95% ELSS funds underperformed in the 1-year period – this becomes 90.59% and 88.10% respectively over a 3-year period.
It means that if you are an investor in such an active mutual fund, odds are that you ended up paying more to get relatively lesser returns. You would’ve been better off paying far less & investing in an index fund or an ETF that tracks the index.
By the way, are you surprised to see that underperformance is far lower for the mid/small-cap segments? The smaller size of these firms means they receive less coverage compared to larger names like Reliance or Infosys – the relative scarcity of information requires superior stock selection skills & robust risk management, especially in an emerging capital market like India. There is value to be added there by good managers. At least at this stage.
However, if you are investing (or thinking of investing) in the large-cap or ELSS segments (i.e the top-200 stocks) I’d strongly encourage you to focus more on costs & consider passive index funds or Exchange Traded Funds (ETFs). After all, while returns can’t be controlled or predicted, the costs can be – and research has shown that invariably the lower cost passive fund ends up beating the high-cost actively managed fund. In fact, data suggests that most active mutual funds in this category don’t add enough value to justify the costs across most time-periods – the odds of outperformance are low. And identifying the winners from the losers in advance is even more challenging.
This trend is even more prominent in developed markets
In such economies, the stock markets have evolved & matured. Check out the same SPIVA scorecard for the United States here, where you can see on Page 9 that more than 70-80% funds across major segments have consistently underperformed the benchmark indices.
Coming back to India, many investors have already started to invest in the index itself, rather than spend money on active fund management that has a higher probability to not deliver. If you own large-cap funds or are thinking of investing in such funds, I’d strongly urge you to research this further & consider investing in low-cost index funds or ETFs instead.
ETFs particularly have become increasingly popular, thanks to its simplicity, transparency, and ultra-low costs. My suggestion, especially if you’re considering investing in one of the two benchmark indices (Sensex-30 & Nifty-50), would be to check ETFs out. Happy investing!
If you’re not sure about ETFs and would like to learn more, check out the first post in the ETF Education series: ETFs 101 – What is an ETF?
Are you a mutual fund investor? Check out this collection of articles written specifically to educate mutual fund investors.