Good guys don’t always win………………..

Assets under management (AUM) in the India’s mutual fund industry is INR 8,800 billion – 2014 KPMG report on mutual fund industry in India. AUM in the most liquid Index fund (Benchmark’s NIFTY BeES) is INR 6 billion, a paltry 0.07% of the AUM for mutual funds. NIFTY has returned 19% annually since 2001, which is phenomenal by any standards and we are sure that this will not be matched by any of the mutual funds.

Research done by Eugene Fama, William Sharpe and Jack Treynor had established that mutual funds on the average do worse than the market. The current data continues to support this research.

  • SPIVA 2014 report for the US – “An inverse relationship exists between the measurement time horizon and the ability of top-performing funds to maintain their status. It is worth noting that no large-cap or mid-cap funds managed to remain in the top quartile at the end of the five-year measurement period.”
  • We could not find the latest SPIVA report for India, this is from the SPIVA mid-year 2012 report, “Benchmark indices continued to outperform a majority of the equity oriented funds over the 5-year time frame, a trend consistently observed across past editions of the SPIVA scorecard”.

We are not saying that active funds cannot beat their benchmarks, because there have been and will always be “some” actively managed funds that outperform the benchmark. There is significant evidence about very few have beaten the markets consistently over long periods of time, i.e., over 5 year period. We believe that it is almost impossible for investors to predict which funds will outperform the market and over what period. As predicting funds that will outperform is not very likely, we believe, investing in mutual funds to create wealth is not a prudent strategy.

Key thing that impacts the performance of mutual funds is their fees, which are anywhere between 1.5% to 3%, whereas fees for Index funds are typically 0.5% or lower.

If one is investing 100,000 per year and is generating a 10% return, in 40 years this would be worth 48,685,181 with no fees,  this would be worth 41, 737,581 with 0.5% fee , this would be worth 35,823,406 with 1% fee and only 19,721,533  with 3% fee!!!.

Mutual funds - pic 1

1% yearly fee reduces the return by 10% over a 15 year period, 19% over a 25 year period and 36% over a 40 year period.  2% yearly fee reduces the return by 21% over a 15 year period, 41% over a 25 year period and 83% over a 40 year period.

Mutual funds - pic 2

If you are looking to invest for a long term goal (over a 3 year period, ideally over 5) and are currently investing in mutual funds we suggest that you consider investing in Index fund/ETF.  If you are already holding mutual funds pl review their performance using XIRR, and if the XIRR is less than 14% you should seriously consider switching to an Index fund.

 


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About Praveen Reddy

http://in.linkedin.com/in/praveenreddyinduswealth

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