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Over the year, the Sensex and the Nifty have gained around 16%, as has the mainstream diversified fund.

2010 has been a strange year for Indian mutual funds. While the funds’ performance has been pretty much as expected—certainly nothing for investors to complain about—the year has been dominated by a markedly negative atmosphere. This has specially been true of the retail –oriented equity and hybrid mutual funds. Practically throughout the year, equity funds have had a net outflow of investor’s funds. Certainly, money has flown in; but more has flown out.

For a year, when the equities markets were positive and so was most funds’ performance, this is unusual. Over the year, the Sensex and the Nifty have gained about 16 per cent, as has the mainstream diversified fund. In bread-and-butter fund categories spread over large and mid-cap funds, the average returns have about equaled the indices and plenty of funds have outperformed the indices.

The outperformers have been sector funds in FMCG, banking and pharma in which most funds have generated returns of 30 per cent or more during the year. However, these are not mainstream fund categories. They have a small number of funds and the number of investors or the total asset base is not significant. Unfortunately, the same cannot be said by the outlying fund category on the negative side. Infrastructure funds have performed quite poorly during the year. This is a large category with 26 funds and about Rs 16,000 crore of assets in it. The average returns for the category are just about 6 per cent. Even the better funds have are in the 10-13 per cent range while a number of funds have negligible or negative returns.

All of the above notwithstanding, the fact remains that investors have not been enthusiastic. One reason for that is that no matter what one reads into equity funds’ 2010 numbers, investors have barely broken even from the crash of 2008. Three-year returns of most equity fund categories are around zero, as are those of the Sensex and the Nifty. Following their basic instincts, many investors waited till their investments were worth the previous peak that had been reached, and then redeemed their investments. Given that funds had had huge inflows back in late 2007, it is likely that many investors were just waiting to break even. This doesn’t make much sense as an investment strategy, but it’s probably an inevitable side-effect of the traumatic losses of 2008.

While that may explains the outflows from funds, the lack of inflows is rooted in the changing business model of mutual fund distribution. With distributors earning much less than earlier, the earlier business model has broken down, and a new business model hasn’t yet evolved. However, investors shouldn’t bother about the business dynamics of running or selling mutual funds. The basics stay the same—the better funds outperform the markets and remain the easiest way to participate in the equity markets. The rest will take care of itself.

This column first appeared in The Economic Times on December 27, 2010