Regulatory changes made in the past couple of years have made it harder for large-cap fund managers to beat their benchmarks. One is the scheme categorisation norms introduced by the Securities and Exchange Board of India (Sebi) in October 2017.
Earlier, large-cap fund managers would invest 30 per cent or more of their corpus in mid- and small-cap stocks to boost returns in rising markets. Different fund houses also defined large-cap differently.
For some, it was the top 100 stocks by market cap and for others, the top 200. Sebi made it mandatory for large-cap funds to invest at least 80 per cent of their portfolios in large-cap stocks, defined as the top 100 stocks by market cap.
“Post-Sebi categorisation, overlapping of portfolios in this category has affected alpha generation. On an average, 10 per cent of assets of large-cap funds are invested in mid- and small-cap stocks, which have underperformed the Nifty50 in the past one year, affecting returns,” says Radhika Gupta, chief executive officer, Edelweiss MF.
Sebi has also mandated that funds should benchmark their returns against the total return index (TRI), instead of the price return index (PRI). While the PRI reflects only price changes, the TRI reflects price changes and dividend paid by stocks. The TRI can be 150 basis points or higher than the PRI for a large-cap benchmark. Fund managers are finding it harder to beat these new benchmarks.
In 2018, the performance of the Nifty50 was driven by just five-six heavyweight stocks. “Fund managers cannot have as concentrated an exposure to just a few stocks in their portfolios as their benchmarks and hence, lagged behind,” says Anil Ghelani, senior vice-president, DSP Investment Managers, who heads the fund house’s passive funds business.
Some experts also hold the high expense ratios of active funds responsible. “If fund managers generate 2 per cent alpha and the fund’s expense ratio is also 2 per cent, then the net alpha becomes zero,” says Avinash Luthria, a Sebi-registered investment adviser and founder, Fiduciaries.
Even over the longer term, active fund managers have found it difficult to outperform their benchmarks. The last S&P Indices Versus Active (SPIVA) Funds India scorecard brought out in mid-2018 had found that 62.77 per cent of large-cap funds had underperformed their benchmarks over the past 10 years. Luthria points out that even if some (say, 37 per cent) of funds outperform, it is difficult to pick in advance which ones will outperform over the next 10 years.
Experts now suggest shifting a portion of large-cap allocation to passive funds. “Shift 20-25 per cent of your large-cap allocation to passive funds,” says Ghelani. When selecting a passive fund, go for those with lower costs. In case of an index fund, just look at the total expense ratio (TER), but when investing in an exchange-traded fund (ETF) you need to worry about the total cost of ownership (which would include TER, brokerage, and bid-ask spread). Luthria advises investing in only the most liquid ETFs.
About 75 per cent of your large-cap allocation will still be in active funds. Gupta suggests investing in funds that follow robust investment processes, are true to label, and have reasonable costs.