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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.
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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
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