Are fund managers really better than you at picking stocks?

Is it better to invest through a mutual fund or simply invest directly in popular stocks such as Infosys and Reliance? According to the latest S&P Indices Versus Active Funds (SPIVA) scorecard, the ‘professional’ fund managers may not be any better at guessing which stocks will go up and which will go down compared to the ordinary man who invests in ‘bluechip’ stocks.

The scorecard, produced by S&P Dow Jones Indices in partnership with CRISIL, has found that the majority of actively managed Indian equity mutual funds have underperformed their respective benchmark indices over the last five years. A benchmark index is a index (a combination of stock values) that is used to compare the performance of a mutual fund.

A mutual fund is an institution that collects small sums of money from individual investors and hires a team of researchers and fund managers to invest that money wisely. In return, the fund takes a proportion of the total investment (about 1-3%) as its fee.

A mutual fund that invests in large companies (large cap stocks) can be compared with the Nifty Index. The Nifty Index is comprised of the 50 biggest stocks on the National Stock Exchange of India, selected in such a way that all sectors of industry are included.

The analysis found that most equity mutual funds underperformed (or could not keep up with) the basic indices like Nifty and Sensex over the longer term. It must be kept in mind that five years ago, the Sensex was at about 15,700 and was at about 16,000 in June this year — the end-period for the study. In other words, the actual return for an investment in Sensex stocks would be close to zero for the five year period. An underperformance means that the mutual fund actually lost money during the period.

Not surprisingly, the analysis found that returns were higher for debt-oriented mutual funds, which invest mostly in debt, with some part in equities (stocks).

The following are the main results of S&P’s analysis according to the type of equity mutual funds –

LARGE CAPS A majority of large cap equity funds failed to beat the S&P CNX Nifty, the leading benchmark index for large-cap companies listed on the National Stock Exchange of India (NSE): 53.33% underperformed their benchmark over the last five years, 57.14% over the last three years and 52.63% over the last year.

DIVERSIFIED FUNDS Over 53.10% of diversified funds outperformed the benchmark S&P CNX 500 in the 1 year period ending June 2012. This number increased to 61.6% in the 3 year period but again dropped to 49.5% in the 5 year period.

ELSS (or tax-saving mutual funds with long lock-in period) The percentage of funds outperforming the benchmark in both the 1 year and 3 year period is stable at about 70% but drops significantly to 44.83% in the 5 year period.

“The underperformance of actively managed funds in comparison to the benchmarks over the latest five-year period demonstrates once again the difficulty for fund managers to consistently outperform the benchmark,” pointed out Simon Karaban, Director at S&P Indices.

The SPIVA report also found that in the twelve months ending June this year (when the stock indices hardly moved), the mutual funds failed to show any improvement in performance compared to indices such as Sensex and Nifty.

The Nifty fell by close to 5% in the past year ending June 2012, while asset-weighted large cap funds fell 5% and their equal-weighted equivalents were down 6%.

Active managers of equity oriented hybrid funds (equity and debt) have also fallen behind benchmarks over both 1- and 5-year time frames.

In contrast, the majority of active managers of debt oriented hybrid funds or Monthly Income Plans (MIPs) outperformed the benchmark CRISIL MIP Blended Fund Index over the 3- and 5-year time frames.

In the one year period ending June 2012, the majority of gilt and balanced funds underperformed, while the majority of debt funds beat their benchmarks.

Jiju Vidyadharan, Director, Funds & Fixed Income Research, CRISIL Research, said: “The mutual fund industry in India through the past few months has been undergoing multiple changes given various regulatory announcements and the rather flat capital markets. Given the environment, the number of new launches has been low and the mutual funds have been in a consolidation phase. Of the different fund categories, the survivorship has been the lowest when it comes to diversified equity funds across categories and time. Whereas balanced funds, hybrid funds, gilt funds and debt funds had a 100% survivorship in the one year period.”

Continuing on the trend observed in the previous editions of SPIVA, the latest scorecard maintains that asset-weighted returns are higher than equal-weighted returns across categories (except for gilt funds) over the 5-year time frame. Asset-weighted large cap equity funds have returned 5.86% over the past five years compared to 4.61% for their equal-weighted equivalents. This indicates that funds with better performance over longer time frames had larger assets under management (AUM).