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Beaten by the Bourses

Indian mutual fund industry no longer finds it easy to outdo the markets

Here’s the dialogue from a couple of Dilbert comic strips a few days ago. Dogbert the CEO is holding forth on his business plans in a meeting: “We’re getting into the financial services game. That way, all our products can be imaginary.” Then, while talking to the pointy-haired boss, he elaborates, “We’ll start 10 mutual funds, each with randomly-chosen stocks. Later, we’ll build our advertisements around whichever one does the best purely by chance. My goal is to be the premier provider of imaginary expertise.”

I don’t know how many mutual fund investment managers would have recoiled guiltily upon reading the strip, but I’m willing to guess that at least a few would.

Does this sort of a thing really happen? Do mutual funds basically operate on this machinegun approach? Launch a lot of funds with a lot of, more-or-less, randomly chosen variations on some general themes, and then basically ride the roll of the dice. The statistical probability is that some fund or the other will always do well and you’ll basically get by.

As it happens, Value Research is currently in the middle of a large project to analyse a fundamental shift, in the relative performance of Indian equity mutual funds, that has made itself apparent over the last three years.

I’ve been tracking Indian mutual funds for almost two decades now, and it has always been clear to me that the Made-in-USA theories, about most mutual funds not being able to outperform the market indices, were simply not true in India. For most of this period, a large proportion of equity funds had consistently beaten the Nifty and the Sensex by a wide margin. There were long periods (as in five years and more) when above 90 per cent of funds would beat the big indices consistently. During the entire period, you would never find a single article or paper by an indexing proponent which would dare to quote Indian data.

However, please note that I’m talking in the past tense. Things have changed. There are still plenty of Indian funds that beat the indices and by good margins, but their numbers are fewer and the list is not consistent. However, while one always expected this shift to happen, what is puzzling is that it seems to have happened at a point of time that can be pinpointed quite narrowly to the market correction of mid-2006. The markets crashed in early May 2006 and resumed their upward march in mid-July, but somehow, the ease with which mutual funds used to keep up with them changed sharply.

During this period or soon after this, the consistency with which funds beat indices declined sharply and has never really picked up. Of course, a bulk of the period after mid-2006 has not been very normal anyway, but I don’t think that’s an explanation. Whatever has happened is of considerable importance to the Indian fund investor and I hope we’ll figure out the mystery soon.