Mutual funds are good, but they fare better in bear markets

NEW DELHI: The performance of active mutual funds seems to have an inverse relationship with market returns as the chances of outperformance increases during periods of lower market returns, shows an analysis done by Kotak Institutional Equities.

“A comparison of the outperformance of large-cap funds shows that more funds and a higher share of AUM tend to outperform during periods of lower market returns. Logically, this finding seems quite plausible,” the report said.

Data shows that the percentage of funds outperforming goes as high as 44 per cent during low market returns.


Unlike passive investing which provides near-total exposure to benchmarks with preceding momentum in stock prices being fed into through higher allocations in rising stocks, active fund managers have a greater ability to deploy more risk management through dynamic exposure allocation or through the use of cash whose value shows up in enhanced way during market downturns.

“Active managers also have a value streak, which leads them to buy the part of the market that has fallen a lot more. This in a way is the reverse of when strong markets present a challenge for active managers, given their cash holdings make outperforming an index (zero cash) more difficult,” says Kotak analyst Abhijeet Sakhare who co-authored the report along with 4 others.

While active funds provide better downside protection during bear markets, strong bull markets tend to bring in lower volatility and higher correlation among stocks, making it more difficult for active fund managers to exploit their stock selection skills.

The study of 200 equity mutual funds shows that the industry has a solid track record on 10-year returns, with nearly 80 per cent of AUM (assets under management) outperforming benchmarks, but when seen on a 5-year and 3-year basis, the figure drops to as low as 40 per cent.

Although market cycles weigh on performance in several ways, aggregate alpha delivered by the industry has declined in the past 15 years, it said.

As the bar for active managers to deliver alpha is getting higher, emerging markets like India still offer more potential for active managers to deliver alpha and to also bring professional investing to a larger set of participants, the analysts said.

The shift towards active investing is getting popular as the markets are becoming more and more efficient. In the US, the world’s largest market, around 40 per cent of mutual fund AUM (across equity, bonds and hybrid categories) are in passive funds.

(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of Economic Times)

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