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Large-Cap Mutual Funds: Big Inflows, Small Returns


Large-cap alphas are now negative with less than one in five funds beating the benchmark.

If there is one theme which stands out in India’s financial sector over the last few years, it is the ‘financialisation’ of savings. Disappointed by the returns in gold and real estate, numerous Indian investors turned to financial markets and drove a bull run across financial assets even when foreign investors turned net sellers. One of the biggest beneficiaries of this trend has been the asset management industry. Between December 2013 and 2018, mutual fund assets under management experienced an increase of more than 175 percent and AUMs of equity mutual funds more than tripled.

A mammoth increase in equity AUMs combined with the mantra that ‘mutual funds mein patience rakhna sahi hai’ calls for an analysis of the long-term performance of equity funds. Within equity as an asset class, large-cap funds have attracted a substantial amount of capital from a diverse range of domestic and foreign investors since they are considered ‘high quality, low risk’. More importantly, they have struggled recently to outperform benchmark indices. Hence, we take a look at the five-year performance of large-cap funds in India between December 2013 and 2018.

Survivorship Rate

We focus on 123 mutual fund schemes which were classified as ‘large-cap’ by Morningstar on December 31, 2013, on the basis of portfolio allocations. Before we go ahead and analyse the performance of these funds, it is important to point out a rarely discussed parameter: survivorship rate. Not all mutual fund schemes survive over long periods of time, either because they are merged with other schemes (for various reasons) or discontinued, usually due to unsatisfactory performance. As of December 31, 2018, only 93 of the 123 schemes were still in existence, implying a survivorship rate of just 75 percent.

The impact of such exits is usually ignored in performance calculations, leading to survivorship bias in the reported returns of any mutual fund category.

Massive Increase In AUMs And Average Fund Size

Over the five-year period, total AUMs for large-cap funds increased by more than 200 percent and average fund size more than tripled. As demonetisation provided a huge impetus to financialisation of savings, the trend has accelerated since then. In the two years after demonetisation, large-cap AUMs increased by more than Rs 1 lakh crore and the average size of large-cap funds almost doubled to Rs 2,900 crore.

Large-Cap Mutual Funds: Big Inflows, Small Returns
Large-Cap Mutual Funds: Big Inflows, Small Returns

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Large-Cap Alphas Are Now Negative, Less Than One In Five Funds Beat The Benchmark

While the increase in AUMs is an unqualified positive for financial markets and the mutual fund industry in the long run, a sudden infusion of capital puts performance pressure on fund managers over the short term. In turn, large-cap funds have recently struggled to outperform a passive benchmark, the S&P BSE 100 index. An analysis suggests that three-year rolling alpha (return over and above that of an S&P BSE 100 exchange-traded fund) has been consistently falling for the last two years and is now negative.

While large-cap alpha peaked at 6 percent in late 2016, by December 2018 it stood at –1.86 percent.

The fall in large-cap alpha has been accompanied by a constant decline in the percentage of funds beating the benchmark. In late 2016, more than 90 percent of the funds were generating positive alphas. But, by December 2018 that number was down to just 16 percent, suggesting that the deterioration in performance has not only been substantial but also broad-based. If we focus on returns over a shorter horizon, the situation looks dire as well. A tough 2018 has brought the average one-year alpha of large-cap funds down to (-)7 percent. In fact, one-year alpha of large-cap funds has been decreasing since early 2015, a result which warrants a closer look.

Large-Cap Mutual Funds: Big Inflows, Small Returns
Large-Cap Mutual Funds: Big Inflows, Small Returns

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Largest Funds Struggled To Outperform Category But Have Recovered

A look at the five largest funds by AUMs reveals some interesting nuances about the performance of large-cap funds. The top five funds have consistently outperformed the category average between 2013 and 2018, except in 2017. One popular hypothesis might provide an explanation: the top five funds have ‘truer’ large-cap portfolios than the average fund.

Since 2017 saw a rally in small-mid cap stocks, funds with higher allocations to large-cap stocks struggled to outperform the category average.

With the reversal in fortunes for small-mid cap stocks in 2018, the largest funds once again generated higher returns as compared to the average fund.

Large-Cap Mutual Funds: Big Inflows, Small Returns

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Fall In Alphas May Not Be Permanent

While the performance of large-cap funds has been concerning, there seems to be considerable support for the idea that alphas might recover from these lows. Two key reasons come to mind.

First, 2018 saw very narrow performance when it came to large-cap stocks. Only 18 stocks in Nifty 50 outperformed the index. “It was a time when the macro narrative was so dominant that individual stock picking – where most of the hard work gets done – was of little consequence”, says Morgan Stanley’s Swanand Kelkar.

It seems very few fund managers, if any, were able to foresee such a narrow rally and hence were quite underweight on the top performers.

Thus, if the performance in 2019 is more broad-based, alphas could bounce back.

Second, fund managers in India still enjoy a structural advantage. Mutual fund AUMs in India are only about 6.5 percent of the total market capitalisation as compared to 48 percent in United States. “So, I think it is possible in India for active managers, as a group, to add more value compared to active managers in the developed world”, says HDFC AMC’s Prashant Jain. Of course, as mutual fund assets grow to capture a significant portion of the market, it will be increasingly difficult for funds to generate a substantial alpha but that might be some time down the road.

For now, the best advice for investors would be: stay put on the mutual fund pitch but fasten your helmets and don’t take your eyes off the ball.

Rohan Chinchwadkar is an Assistant Professor of Finance at IIM Trichy and Shwetabh Sameer is a Senior Analyst at Morningstar.

The views expressed here are those of the authors and do not necessarily represent the views of Bloomberg Quint or its editorial team.