Is your alpha-chasing habit compromising your goal?

The Indian market, after touching an all-time high in February 2020 plunged to Covid-19 outbreak. The market has corrected significantly since then but has managed to regain its earlier levels last month.

Despite the ride where the short-term movement was significantly strong, the fund manager has been unable to outperform the benchmark.

NSE Nifty 50 performance in 2020

While the market has come back to pre-Covid levels, it provided multiple opportunities for active funds to generate alpha (higher returns against the benchmark).

Let us see how the active and the passive funds performed during the short-term and the long-term in the Indian market.

The SPIVA (S&P indices versus active) report compares the performance of the actively managed fund, and passive funds over the multi-trailing period of over 1 year, 3-year, 5-year, and 10 years.

The H1 of 2020 remained volatile, whereby the large-cap benchmark (S&P BSE 100) corrected by 14.39%. During H1, there was a sharp correction in Q1 of CY2020, followed by a strong rebound in Q2 of CY2020 with the benchmark index rising 20% with support by the economic relief package and easing monetary policy. The investors during the period tactically shifted their allocation from equity to fixed income.

First Half 2020 Average Fund and Index Performance

Considering the SPIVA report, the fund managers have been unable to outperform the benchmark. Over H1 2020, 45.16% of the funds underperformed the S&P BSE 100. The underperformance, of fund managers, holds true in the case of the long-term horizon.

Over longer horizons, the majority of the actively managed large-cap equity funds in India underperformed the large-cap benchmark, with 67.67% of large-cap funds underperforming over the ten years ending in June 2020. Over the same period, Indian large-cap funds witnessed a low survivorship rate of 65.41%.

 Percentage of Funds Outperformed by the Index (Based on Absolute Return) over the long-term

How should investors behave if they are chasing a goal?

Let us now see how could you invest. It goes on without saying that an active fund comes with a higher expense ratio which goes toward fund management and other related costs.

On the other hand, the expense ratio for passive funds has remained low, given there is an underlying benchmark to mirror and active share is negligible. We, at EduFund, believe that an investor should not chase alpha as doing that may derail the person from his/her investment objective.

Instead, he should explore the possibility of going ahead with cheaper passive funds to get the cost-benefit and also better risk-adjusted returns. We believe while an investor should have exposure to active funds but going all-in into active funds may not be the right strategy.

We believe an investor can have a balance between active and passive to ensure that the risks are minimized.

Let us see the performance of an Active fund and a Passive fund –

Assuming you invest Rs 10,000 in SBI Bluechip Fund (Direct plan, Growth option) and the same amount in SBI Nifty ETF, you tend to accumulate a higher amount in the other case as compared to the former.

To cut the story short, if you are chasing an objective such as – global quality education for your child, it is imperative you need to keep aside a hefty amount towards the goal.

While you will be exposed to the active risk while investing in an actively managed mutual fund, you will also be exposed to currency risk where the rupee is depreciating against the dollar.

So, in such scenarios instead of dealing with multiple risks for one objective, you should consider investing passively in an Index fund and even then, would be able to achieve the corpus for your objective.