Investors should use a mix of active and passive funds.
S&P Dow Jones cap Indices recently published the S&P Indices Versus Active Funds (SPIVA) India scorecard for the year ending December 2023.
Over a five-year horizon, 85.7 per cent largecap funds failed to beat their benchmarks. The number was lower at 58.1 per cent for the mid/smallcap category.
Key takeaways
Active funds are struggling to beat their benchmarks, especially over longer horizons.
"To think that just by investing in active funds you will be able to enjoy alpha is incorrect. Do not ignore passive funds just because they give returns similar to their benchmark," says Siddharth Srivastava, head-ETF (exchange-traded fund) product and fund manager, Mirae Asset Investment Managers (India).
Largecap active funds' performance has improved over the past year.
"Only 51.6 per cent largecap funds have underperformed the benchmark over this period, much lower than in past SPIVA reports," says Ravi Saraogi, co-founder, Samasthiti Advisors.
One reason for this, according to him, is that largecap funds are allowed to have 20 per cent exposure to mid- and smallcap stocks, which have very well.
Over the three, five and 10-year periods, the largecap category's performance remains poor.
In the mid-/smallcap category, 73.6 per cent of funds underperformed over one year.
Some experts are of the view that the clubbing of the midcap and the smallcap category and comparing this merged category's performance with the S&P BSE 400 MidSmallCap Index has blurred the picture.
"One would have preferred to see segregated data for the midcap and the smallcap categories. And their performance should have been compared to indices such as the S&P BSE MidCap and the S&P BSE SmallCap index respectively," says Saraogi.
"That would have been more informative, even if the number of funds in each category was small," Saraogi adds.
Actionable points
The SPIVA report makes a strong case for going passive.
"Investors should just stick to a single market cap weighted passive index fund based on the Nifty 50 index," says Avinash Luthria, a Sebi registered investment advisor (RIA) and founder, Fiduciaries.
He does not recommend midcap and smallcap funds due to their potential for high volatility.
Despite nearly 50 per cent largecap funds beating the benchmark over the past year, financial advisors are not convinced about going active in this segment.
"Based on one-year data, the chance of outperformance still remains only 50:50. Longer-term data, moreover, suggests that passive is the way to go in this segment.
"For this view to change, active largecap funds would have to show sustained outperformance," says Saraogi.
The performance of midcap and smallcap funds, according to Saraogi, is better when compared separately to a midcap index and a smallcap index respectively.
"In these segments, I recommend going with active funds," he says.
Build core and satellite exposure
Investors should, according to Srivastava, use a mix of active and passive funds. Many advisors use the concept of core (70 per cent of total) and satellite (30 per cent) portfolios.
The core portfolio should have safe assets with low volatility. A Nifty 50-based passive fund is an ideal fit here.
In the satellite portfolio, investors may take some risk to generate outperformance. They may include midcap and smallcap funds, factor funds (the more volatile ones), and so on, here.
Index fund or ETF?
Most advisors favour index funds for retail investors, as they are simpler.
"Go with any Nifty 50-based fund having an expense ratio of 20 basis points or less," says Luthria.
According to Srivastava, when choosing an index fund, one should compare the expense ratio and the tracking error/tracking difference (measures of how closely the fund replicates the benchmark's performance).
Lower is better for all these criteria.
Saraogi suggests going with an index fund with at least a five-year track record and sticking to one of the top five by AUM.
In an ETF, investors need to (in addition to the criteria mentioned above) check liquidity on the exchanges.
"The ETF should have maintained a trading volume of at least 1 crore every day in the recent past and should not pay out dividends," says Luthria.
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Feature Presentation: Ashish Narsale/Rediff.com
