MF Performance: What Defines It?

Is there a reason why mutual funds tend to perform or outperform? A study of the performance of the equity funds over a three year period suggests none, says Shashikant.

The Securities and Exchange Board of India (SEBI) recently raised concerns over the longterm underperformance of several mutual fund schemes and said that it will probe the matter. Such underperformance directly impacts the entire mutual fund industry, and is the principal reason why investors lose interest in mutual funds. In the last nine months, equity funds lost almost 11 lakh folios, with the total number falling to 3.71 crore at the end of May 31, 2012. Within these, the number of retail investors has shrunk the most. Although SIP redemptions are being bandied about as the main reason for such a fall in the number of folios, one cannot ignore the underperformance of the schemes. So why is the entire industry, which is supposed to be one of the best financial intermediaries to channelise retail savings into the capital market, languishing in performance? Is it that a few schemes or fund managers are letting the performance down? We at DSIJ analysed the performance of all the equity diversified schemes (including sector funds) that have been in existence for more than three years to try and find an answer to these questions. To this end, we have analysed 294 schemes from 36 fund houses on various parameters like the fund managers’ track record, turnover ratio, category returns, etc. (Datasourced from valuresearchonline.com)

On the overall performance front, we find that out of the 294 schemes, almost 50 per cent (145 schemes) have underperformed their benchmarks over the past three years. If we look at the fund houses that lie in the lowest rung of performance, there are many contenders, all of whose schemes are underperforming their benchmarks. Nonetheless, LIC Nomura, with all its 11 schemes showing underperformance over the last three years, should get the award for being the worst performer. No other fund house with such a large number of schemes has underperformed as badly. There are also five other fund houses whose schemes have underperformed badly.

However, there are some fund houses, all of whose funds have beaten than their benchmarks. Chief among them is BNP Paribas, whose four funds have managed to outperform their benchmarks. Other funds that managed a 100 per cent outperformance include AIF and Quantum.

So, what is it that differentiates the performance of these two opposite types? Is it the volatility or the churning of portfolios, the fund size or the stock selection?

Surprisingly, we find that volatility has not helped the schemes to outperform. On the contrary, the schemes with high volatility have underperformed their benchmarks. For example, all the schemes of the best performing fund house BNP Paribas have lower volatility, while those of LIC Nomura have higher or above average volatility.

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Is it the churning of portfolio that helps (or rather does not help) the schemes to outperform or underperform? We observed that there is no consistency in this factor either. LIC Nomura’s 11 funds had a turnover of just 13.45 per cent on an average last year, whereas both the schemes of Quantum that have outperformed have a turnover of just 10.16 per cent. Another well-performing fund house, BNP Paribas, has a churning ratio of 84.25 per cent, which is more than the industry average of 57.55 per cent.

Now, let us take a look at how the expense ratio plays a role in the performance of schemes. Here, we observed that there is no direct correlation between the better performance of a fund scheme and its expense ratio. For example, Quantum, which is one of the best performing fund houses, has an expense ratio of just 0.88 per cent as compared to an average of 2.08 per cent. Whereas SBI MF’s four funds, which have all underperformed their benchmarks, have an average expense ratio of 2.24 per cent. However, this does not mean that there is any inverse relation between the expense ratio and the scheme’s performance, as we see that the well-performing BNP Paribas has an average expense ratio of 2.49 per cent.

One may argue that the category (sectors and market cap) plays an important role in determining the returns of the fund houses, as fund houses launching funds under a particular category will hugely impact the overall performance of the fund house. For example, infrastructure as a sector has been one of the worst performing sectors over the last few years and hence any fund house that has more schemes under this category is bound to underperform. But one needs to understand that even the benchmarks should have not performed well as the same rule applies to the outperforming sectors. This is the reason we find that two out of three pharma dedicated funds have underperformed the benchmark, as the benchmark itself has returned an annualised 25 per cent over the past three years. Similarly, only 50 per cent of the infrastructure dedicated fund haves underperformed their category.

Last but not the least, let’s try to see if the fund size is impacting the performance. We see that lower average asset under management (AUM) definitely helped BNP Paribas and Quantum, which have an average AUM of `59.23 and 53.68 crore respectively, to perform well. But, this is not the case with other good performing fund houses like AIG and JP Morgan, which have an average AUM of `145 and `223 crore respectively.

In sum, one could conclude that there is no one particular reason or a set of reasons why mutual fund schemes are likely to perform or underperform in particular circumstances. It is always better to look out for a combination of factors defined according to your investment needs before deciding whether or not to invest in mutual fund schemes.