Mutual Fund Performance Benchmarking
Globally the active passive debate continues to gather steam and currently it seems the odds are stacked firmly in the favour of passive. 2016 was a classical case in point where Vanguard passive funds received inflows greater than the entire industry combined. As per the Morningstar Active/Passive Barometer, which tracks the performance of US Active Equity funds versus their passive peers. Whilst the last 1 year has been good for active funds, overall the success rates for active funds remains muted between 20-30% on a 5 year return basis.
Closer to home, the debate is yet to turn meaningful. Whilst Index/ETF flows have gone up, this is predominantly on the back of EPFO money moving into a couple of ETFs. This debate recently got a much-needed shot in the arm when DSP BlackRock announced that they would be benchmarking their Funds to the Total Returns Index (TRI). Let’s understand what this move signifies.
TRI takes into account not just the Price returns of the stocks but also the dividends paid out on the stocks. The typical dividend yield on our benchmarks is in the ballpark of ~1.5% pa; this means that the TRI benchmark will be harder to beat by 150 bps pa. Globally Total Returns Indices are commonly used as the primary benchmarks for comparing fund performance, but in India this trend is just taking off. Using TRI paints a complete picture of the alpha being generated by active fund management. Mutual Funds receive dividends and the same is included in the NAV, then why shouldn’t we use a benchmark that captures these dividends so as to make a fair and transparent comparison. Historically Indian indices have always been tracked for the Price Return, but now you can find historical Total Returns data for most indices, although they are not widely tracked yet.
Performance of Active Funds
We compared the alpha generated by Large Cap Funds over the broader market benchmark both on a Price Return as well as a Total Return basis. As observed over a 5 year basis the Total Return of the S&P BSE 100 is 165 bps pa higher than the Price Return. As expected the number of funds beating benchmark drops from 85% to 58% after making a comparison with the TRI instead of the PRI. That said, this still a fairly healthy number of funds beating the benchmark. The reasons for this outperformance could be multifold – superior stock selection, off benchmark picks, style drift, inefficient markets, etc, but that is a discussion for another day.
Table 1: Large Cap Funds (31st August 2017)
We believe the move towards TRI is a positive one and would expect the other asset managers will follow suit soon. Making a comparison versus the TRI paints a fair and complete picture of the comparison of the alpha being generated through active management, so that investors can take a judicious call while making their investments. Funds should adopt this higher standard of reporting which increases the transparency to investors.
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