All of us tend to learn from mistakes of the past. In a similar vein, it is important for investors to learn from the under performance of different mutual fund schemes.
There have been many MF schemes which have offered negative yields even after they have been held for ten years. In addition to identification of such historically underperforming schemes, we also need to take learnings from each of them.
Presented below is a study of varied mutual fund schemes performance over a ten year period. During this period, the funds have had 1 complete up and down cycle to yield returns and perform. The debt fund market has also undergone several cycles of interest rate fluctuations during this 10 year period.
- Diversified equity funds
On an average, diversified equity linked mutual funds that were actively managed did do better as compared to their respective benchmarks.
The CAGR analysis over 10 years shows the outperformance of such diversified equity funds vis-à-vis their benchmarks.
|Category||CAGR (%)||Benchmark||CAGR (%)||Margin of outperformance|
|Diversified large cap||9.05||S&P BSE sensex -TRI||7.33||1.72|
|Diversified mid cap||13.15||S&P BSE mid cap||7.88||5.26|
|Diversified small cap||14.17||S&P BSE small cap||6.46||7.71|
|Diversified multi cap||10.29||S&P BSE 500||7.04||3.25|
|Balanced equity linked funds||10.22||CRISIL balanced fund – aggressive index||7.63||2.59|
It may however be noted that there are many schemes which performed below par as compared to their benchmark. Hence, the experience of investors will be dependent on the returns provided by individual MF schemes. For example, many large cap mutual funds provided very low yields for a holding period of 10 years. It is important to move out of these funds if the AMCs do not kill them.
|Scheme||NAV (INR)||AUM ( INR cr)||Scheme return (%)||Benchmark (S&P BSE Sensex – TRI) (%)||Underperformance|
|JM Equity Fund||63.51||5719.75||2.34||7.33||-4.99|
|Taurus Bonanza Fund||73.83||113.11||4.10||7.33||-3.23|
|LIC MF Equity Fund||43.23||329.04||4.39||7.33||-2.94|
With regards to mid cap funds, just Taurus Discovery Fund has not done as well as its benchmark. In case of multi cap schemes, the under performers are Taurus Star Share Fund and UTI Bluechip Flexicap Fund. You do not need to immediately get rid of these underperforming funds. This is due to the fact that MFs may employ the recent guidelines of SEBI for reduction of the number of schemes as a means to get rid of the underperforming schemes.
The key learning from the above data is the fact that you need to periodically review the MFs held by you. Investors should closely monitor all their funds so that they are not stuck with perpetually underperforming schemes.
Now the question that arises is how often do investors need to review their investments in MFs. A review once every quarter is good enough! You will just be checking up on the performance of the funds and reviews usually do not require any action from you. You may think about taking action only when there is continuous underperformance by a scheme for 6 or 8 quarters.
People who regularly review the portfolio often sense issues with funds well before 5 to 6 quarters. You need to become more careful about a fund that gets beaten by its benchmark performance for 3 continuous quarters without any solid cause.
Investors have to engage in both quantitative and qualitative analysis in order to find out the cause/causes of underperformance of a scheme. For example, IDFC Premier was a really great performer. Its performance significantly dipped after the fund manager left. This is valid reason for you to move out of the fund.
Investors also need to consider underperformance over short term durations when a long-term view is being held by the fund manager. A good example is the Prashant Jain managed HDFC Funds. The funds were underperforming due to excessive exposure to public sector banks, but the fund manager was sure that it will all become better. Hence, investors were advised to remain invested in the funds. After the recent decision of recapitalization, there was a 5 percent jump in HDFC Top 200 in late October 2017.
- Balanced funds
There are some AMCs that look the same in the balanced funds segment. With over 65 percent exposure to equity, the rules stated above are also applicable to these types of balanced MF schemes. It is important for investors to get rid of perpetual underperformers and stay invested in funds with short-term underperformances.
A few balanced mutual funds have yielded low returns. Balanced MFs are a good long-term option as the debt part of the fund will become tax free after 1 year.
|Scheme||NAV (INR)||AUM ( INR cr)||Scheme return (%)||Benchmark (CRISIL Balanced Fund Aggressive Index) (%)||Underperformance|
|JM Balanced Fund (G)||44.44||2428.85||3.74||7.63||-3.89|
|LIC MF Balanced Fund (G)||93.69||224.75||5.33||7.63||-2.30|
|DHFL Pramerica Balanced Advantage Fund (G)||65.05||205.06||6.26||7.63||-1.37|
For example: HDFC Prudence underperformed for a short period of time. It however jumped by 4 percent in late October. Balanced fund investments also come with some extra benefits. The most key advantage is on the tax front. The debt part of the fund incurs tax like equity. The debt section of the portfolio also provides stability. There may be some forced necessary rebalancing because of the debt portion and this may be the reason why balanced MFs as a category provided returns nearly as good as the returns of diversified equity mutual funds.
- Sector funds
Many theme-based and sector funds were in the list of the MF schemes which offered really low absolute returns over the past ten years. A few of them such as DSP Blackrock World Gold Fund and Escorts Infrastructure Fund, etc., have yielded negative returns even post ten years holding period. Common investors need to stay away from theme-based and sector funds and remain invested in diversified mutual funds. Thematic or sector funds are typically designed for ‘good’ investors who know a theme or sector. Other investors have a herd mentality and tend to make investments in sector funds during peaks.
Some of the blame needs to be shared by mutual funds. During the bull market period of 2000, AMCs were very busy offering tech mutual funds. In the same manner, many fund houses also introduced infrastructure funds in the year 2007 and this resulted in heavy losses for investors. Thematic or sector funds are for plays in the short term and are not a tool for creation of wealth over the long term. This is due to the fact that sector cycles tend to be short and money can be made by investors only when such cycles are correctly determined.
Another reason is the overall growth in the country. The economy in India is showing improvement and overall growth across different sectors. This growth is going to be better captured by diversified mutual funds. Another problem with sector funds is minimal or nil diversification. Most retail investors opt for MF investments just for the diversification and this purpose gets defeated by sector funds. The combined portfolio that results after the selection of 3 to 4 sector funds becomes similar to that of diversified MFs. Instead of investors choosing the different sectors, leave this task to the fund manager. The fund manager is getting paid to make the right choices.
- Index funds
An analysis of the performance of Index funds has thrown up astonishing facts since most index funds generated returns lower than its respective indices. It may be argued by different fund houses that such indices get calculated without taking into account the involved costs and hence the returns of index mutual funds tend to be less. It may however be noted that the comparison being done here is with the normal index; it is not with TRI or total return index which also takes into account the effect of dividends.
One of the main chronic issues with index funds is high cost. Actively managed mutual funds keep generating alpha and this option is not viable for people making long-term investments.
|Scheme||NAV (INR)||AUM ( INR cr)||Scheme return (%)||Benchmark (Nifty 50 Index) (%)||Underperformance|
|LIC MF Index Fund-Nifty Plan||56.33||21.69||5.34||6.4||-1.06|
|HDFC Index fund –Nifty||91.19||254.85||5.81||6.4||-0.59|
|SBI Nifty Index Fund||86.67||196.08||5.84||6.4||-0.56|
|Scheme||NAV (INR)||AUM ( INR cr)||Scheme return (%)||Benchmark (Sensex) (%)||Underperformance|
|LIC MF Index Fund-Sensex Plan||60.42||14.43||4.78||5.80||-1.02|
|Tata Index Fund –Sensex Plan||79.24||7.06||5.44||5.80||-0.36|
|HDFC Index fund –Sensex||284.89||100.27||5.47||5.80||-0.33|
The dividend returns as per the Sensex is currently at about 1.2 percent. Such underperformance occurred primarily due to higher historical cost as compared to the dividend yields. High cost thus remains the major issue. Expense rations levied by index mutual funds tend to be high and it need to reduce to not more than 0.2 percent. A better option in the current scenario is ETFs or exchange traded funds.
Continuous generation of alpha by actively managed MFs means that one should not consider this category as a means of wealth generation in the long term. The concept of parking money in index funds and forgetting about it is good for only the developed economic markets and not for a growing market like India.
- Debt funds
Analysis of different categories of debt funds have also thrown up surprising results. The CAGR over 10 years for the category of long-term income was just 7.88 percent. This is lower than the returns of 7.99 percent provided by its benchmark, i.e., the Crisil Composite Bond Fund Index. As observed in the chart of income funds, a few of these funds also show gross underperformance vis-à-vis the benchmark.
Income funds are not suitable for generation of long-term wealth corpus. It is better to go for options such as Short Bond Funds for putting in long-term savings.
|Scheme||NAV (INR)||AUM ( INR cr)||Scheme return (%)||Benchmark (Crisil Composite Bond Fund Index) (%)||Underperformance|
|JM Income (G)||47.09||39.68||4.72||7.99||-3.27|
|L&T Triple Ace Bond Fund – Reg (G)||42.86||506.89||5.82||7.99||-2.17|
|Sundaram Income Plus(G)||24.71||504.49||6.3||7.99||-1.69|
It is also really important to note that the returns from a few of these funds were extremely low; the returns were lower even as compared to the inflation over the past ten years. It is important to remove the underperforming schemes from debt fund portfolio with the help of methods stated above.
There is another category of debt funds called MIPs which come with minor exposure to equity. The average return of this category was 8.93 percent and it thus beat its benchmark (Crisil MIP Blended Fund Index) return of 7.9 percent for the same period. It may however be noted that some of these funds did underperform and fail significantly.
The equity part in MIPs gets taxed like debt. People who desire minor exposure to equity should opt for equity savings funds.
|Scheme||NAV (INR)||AUM ( INR cr)||Scheme return (%)||Benchmark (Crisil MIP Blended Fund Index) (%)||Underperformance|
|Baroda Pioneer MIP||22.05||31.49||5.82||8.11||-2.30|
|LIC MF MIP||50.87||112.51||6.43||8.11||-1.68|
|BNP Paribas MIP Fund||26.78||333.02||6.89||8.11||-1.22|
Investment experts are of the opinion that use of MIP for wealth generation in the long term is completely unnecessary. This is due to the fact that the equity portion also gets taxed like debt, which is the exact opposite of the benefited offered by balanced mutual funds. The category of equity savings, which get taxed like equity after 1 year, is a better investment option than MIPs. Another choice for investors with low appetite for risk is dynamic asset allocation mutual fund.
It may however be noted that debt funds can be a great choice during the distribution stage, i.e., after retirement. Short term income funds are a good option during this stage as they tend to offer better returns as compared to fixed deposits in banks. Also, they are comparatively more efficient when it comes to taxation.
Source: ET Wealth