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The times won't change back

There was a certain golden period of equity fund investing and investors need to come to terms with its end

The times won't change back

Mutual fund investors are a deeply worried lot. Not because of the volatility this year - that worry is over for the time being - but because the long-term and deep decline in equity mutual fund returns is now undeniable. Often, depending on their own experience, investors frame this as a failure of the particular funds that they themselves are invested in. At any given point of time, some other fund is always doing better and it's easy to point that out. More sophisticated investors who are able to explore data or track their portfolios on Value Research Online can also make systematic comparisons with the benchmark indices and generally come away just as unhappy.

Those of us who have access to the aggregate opinions of a lot of investors can see the bigger picture and it's not a particularly happy one. The dissatisfaction with equity mutual fund performance is widespread and here's the interesting thing - it's far deeper in investors who have been around for 10-15 years or more. There are two reasons for this. One, these investors have larger - often much larger - amounts invested in equity mutual funds than new investors so their disappointment is that much larger. They are often older, so they invest more and they have had more time so the investments have grown much more.

However, there is a third factor that is a much bigger source of the bitter disappointment they feel: older investors have seen some truly great times as equity fund investors. The period from 1999 to early 2012 was absolutely fabulous for equity mutual funds, despite some big hiccups. Even those who invested in relatively poor funds made great returns. And for those who invested in the better funds, it was like printing money. Nowadays, people fish around trying to compare equity fund returns to fixed income and inflation rate to try and prove some point but in those days, the differential was absolutely, ridiculously one-sided.

Take a look at some of the annual returns percentage that were generated during that golden age: 80.1, 78.7, 15.5, 42.9, 50.6, 47.3, 79.5, 18.8, 28.5, 32.1. There were a couple of crashes during that time but the good years were so good that it did not matter. To appreciate that, look at the five-year average of the annual returns from 2004 to 2013: 18.1, 23.3, 17.1, 29.8, 40.3, 30.7, 30.9, 31.4, 20.4, 16.7. Notwithstanding the two giant crashes that are encompassed in those years, if you held on for five years or more, this was your experience. No wonder mutual fund investors who were invested during that period are a sullen lot now.

I wish I had some good news to deliver at this point - like some logic that shows how those years are just on the verge of coming back. If you want that kind of optimism, then you should talk to some salesperson - I have no such rosy vision to sell you. Those days are gone. Investors from a certain time have this feeling that those days were the normal and what we are living through now are the exception. Sorry, but it's likely to be the other way around. There will be times like that once in a while but in a manner of speaking, those returns were excess and unjustifiable and subsequent years are essentially a reversion to mean.

Whatever be the case, right now we have to deal with this reality. Even now, unlike fixed income, equity mutual funds will sustain returns that are comfortably higher than the inflation rate. That can be taken as a given. However, there are some important ifs and buts. The time of passive funds is coming and, in some ways, it's already here. The choice for Indian investors is still poor. Part of the reason is that just as investors are earning for those old days, fund-industry executives are also doing the same. At some point, the fund industry too has to get serious about low-cost passive investing -maybe it will take a regulatory push as so many things seem to do nowadays.

Traditional investing virtues like careful fund choice, asset allocation and asset rebalancing assume a far greater importance. In the good old days, one could ignore all this and still come out on top. That will not happen now.