A Second Look at the Indian Mutual Fund Landscape

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About eight months ago, one of our contacts in India (Jatin Visaria) sent us an analysis of fifty of the largest mutual funds domiciled in India that had at least fourteen years of returns data. We published this article discussing the results of that analysis. Below is the chart that we produced from that data.



Recently, Jatin sent us a compilation of returns data on 244 funds that have at least five years of data as of 12/31/2013. He performed a statistical analysis of their calendar year returns against two exchange-traded funds (ETFs) from Goldman Sachs that track the most widely followed indexes of Indian stocks, the Nifty (large cap) and the Junior Nifty (mid cap and small cap). To test for statistical significance of an alpha, the following formula and form can be used.

When compared to the Nifty-based ETF, twenty-three of the funds had significant alpha (t-stat in excess of two). However, eighteen of those twenty-three only had significant alpha because they enjoyed abnormally high returns in their first few years that were not repeated in subsequent years. Two of the remaining five funds were mid-cap funds, so the Nifty ETF was not the right benchmark for them. This leaves only three funds or about 1.2% of the sample. Ten funds actually had significant negative alpha (t-stat below -2). While it is true that an index fund with zero tracking error and a constant expense ratio would also have significant negative alpha compared to its underlying index, the magnitude of these negative alphas ranged from -2.8% to -18.4%.

Comparing these 244 funds to the Junior Nifty-based ETF yielded much worse results. Only twenty-four (or 10%) had positive average alpha, and none of them had significant alpha. Of the 220 funds with negative average alpha, fourteen had significant negative alpha ranging from -8.1% to -26.1%. 

As Jatin emphasized to us, we are only looking at funds that survived to 12/31/2013. For every fund that had outperformance in its first few years, there was likely to have been one that had underperformance and then either merged or shut down. Indeed, a report by Dimensional Fund Advisors (The Mutual Fund Landscape) that we summarized here found that only 51% of US-domiciled equity funds survived over a ten year period.

Jatin performed a second analysis that, in our opinion, put the final nail into the coffin of active management. Specifically, he obtained a list of 1,378 individual Indian stocks that had ten years of returns data through 12/31/2013. Next, he formed 1,000 random portfolios of fifty of these stocks, the equivalent of a monkey throwing darts at the stock pages. Of the 83 mutual funds with at least ten years of data, only five beat the average or median return of these portfolios. As we discussed with Jatin, although there is a survivorship bias in this analysis (the fund managers could have chosen stocks that got de-listed), the result is not due to the managers picking the wrong stocks but rather their inability to overcome their costs (fund fees and trading expenses).

As we have noted previously, indexing in India is still in an emerging stage, but it is definitely making significant inroads. It is our belief that as more data comes to light, increasing numbers of Indian investors will arrive at the realization that they are better off passive. This phenomenon appears to be in full gear in the US, and it is definitely picking up speed in the UK. As the country with the world’s second highest population and an economic growth rate well ahead of our own, India could end up having an enormous impact on the future of investing. We look forward to seeing how it all unfolds, and we are happy to have our contacts there like Jatin to keep us informed.