Moneycontrol Pro Panorama | Market returns: A wake-up call for fund managers

Investors have moved out of actively managed funds and into low-cost index funds. Despite access to some of the best research from highly paid analysts. (Image: Shutterstock)

Dear Reader,

The Panorama newsletter is sent to Moneycontrol Pro subscribers on market days. It offers easy access to stories published on Moneycontrol Pro and gives a little extra by setting out a context or an event or trend that investors should keep track of. 

Every time mutual funds’ returns fail to beat benchmark indices, one is reminded of the bet Warren Buffett had placed with Protege Partners, a New York City money management firm that runs funds of hedge funds, on an index fund beating an active manager.

The bet was to play out over a 10-year period commencing January 1, 2008, and ending December 31, 2017, during which Buffett said the S&P 500 would outperform a portfolio of five hedge funds of funds when performance was measured on a basis net of fees, costs and expenses.

Buffett selected the Vanguard Index Fund as a proxy for the S&P 500. He won the bet by a mile as the five funds of funds had an average return of only 36.3 percent net of fees over that 10-year period while the S&P index fund had a return of 125.8 percent.

Indian fund managers have also done equally badly. During 2022, over 87 percent of active large-cap schemes failed to outperform the benchmark S&P BSE 100, says a report by S&P Dow Jones Indices. During the 3-year period (CY 2020, ’21 and ’22), the percentage of schemes underperforming the index was even higher at 97 percent.

Underperformance was noticed across all schemes. Consider this, 55 percent of actively managed mid- and small-cap equity funds gave lower returns than their benchmark, the S&P BSE 400 MidSmallCap Index. Similarly, 77 percent of equity-linked saving schemes (ELSS) have under-performed their benchmark S&P BSE 200.

The underperformance has not gone unpunished. Investors have moved out of actively managed funds and into low-cost index funds. Despite access to some of the best research from highly paid analysts, these high-cost fund managers have found it difficult to beat the index.

The underperformance is disturbing as unlike an index fund, which is always fully invested in stocks comprising the index, active fund managers have the option of sitting on cash when they feel it’s not the right time to deploy capital. They can also hedge their positions to protect against any downside move, which an index fund that mimics the index does not.

With 97 percent of the funds underperforming their benchmark indices over a 3-year period, it is time the mutual fund industry took a closer look at itself. If it cannot beat the benchmark, then the least it can do is stop charging high fees to investors who think they are giving their money to ‘experts’. It is high time that the market regulator SEBI took a relook at the total expense ratio (TER) by linking it to size.

As our Chart of the Day shows rising financialisation, outperformance by MFs can help increase financialisation of savings.

Investing insights from our research team

Par or sub-par monsoon? — Bracing for the worst case!

Why is yellow metal’s glitter not rubbing off on this leading gold-financing NBFC?

Speciality Restaurants: Geared up for the next level of growth

Power Grid Corporation of India: Poised for better performance

What else are we reading?

The Chip Wars: Why India should have a long-term, comprehensive chip plan

IMF sees real rates falling sharply, but don’t ignore the caveats

Winning the NIM game in FY24 will be tougher for banks

GuruSpeak | Gaurav Jain: A faraway event saw this full-time trader chose discretionary trading over systems

Martin Wolf: Japan, Germany and the challenge of excess savings (republished from the FT)

Increased scrutiny of bank-fintech alliance puts start-up ecosystem at risk

On the US and China, Emmanuel Macron just voiced an important concern for Europe

Thailand’s new-found economic stardom comes with caveats

Is Substack Notes on its way to replace Twitter?

Technical Picks: Infosys, FACT, Tata Steel, Navin Flourine and Crude oil (These are published every trading day before markets open and can be read on the app).

Shishir Asthana
Moneycontrol Pro