Passive investing helps

Vivek Kaul

If this year has been bad for the stock markets, it has been worse for mutual funds. Mutual fund net asset values (NAVs) have fallen much greater than the broader market.

Even those investing for 2-3 years have seen a substantial fall in the values of their portfolios. Fund managers who seemed to do no wrong until a few months back, are now an embarrassed lot. Even over longer periods, there is little evidence that active investing works.

As Peter L Bernstein writes in Capital Ideas Evolving, “In 2004, Burton Malkiel of Princeton, and author of A Random Walk Down Wall Street, studied all mutual funds in existence since 1970 — a total of 139 funds surviving over more than thirty years.
He found that 76 of the funds underperformed the market by more than one percentage point a year; only four funds outperformed by more than two percentage points a year. Malkiel reports that more than 80% of the actively managed large capitalisation funds covered in the Lipper Analytical Services failed to match the returns of S&P 500 over periods longer than 10 years ending in 2003. Malkiel also points out that “there’s almost no persistence in excess performance… In decade after decade, the top funds in one period are often the bottom funds in the next… There’s no way to tell in advance which funds will outperform.””

So, the five star funds of today may not be the best performing funds of tomorrow. Take the Sundaram Select Midcap Fund, which was the darling of investors till about a year back. The scheme has given a return of 15.78%, against the category average of 20.745%. The fund managers were clearly not able to manage the deluge of new money into the scheme.

So, the best option for investors is to invest in index funds — mutual fund that index stocks in the same proportion as their proportion in the index. But, often fund managers are guilty of trying to actively manage these funds. In this situation, it makes sense to invest in the few exchange traded funds currently available.