Tag: mutual funds

Mutual Funds: A quick note on performance metrics

There is absolutely zero stability in metrics used to analyze mutual fund performance. Whether it is alpha, beta or information ratio, they all vary over time and across market environments. Using them to pick the next “winning” fund is pointless. They are, at best, a measure of what happened in the past.

We take a 200-week sliding window of midcap mutual fund returns and calculate its alpha, beta and information ratio. Here’s how these numbers stack up for the HDFC Mid-Cap Opportunities Fund.
HDFC Midcap fund

What is apparent here is that

  1. There is no case for dropping a fund because of declining alpha. Alpha keeps changing through time.
  2. You cannot escape negative beta.
  3. Managers seem to be able to outperform on the way up but not under-perform drastically on the way down. This is asymmetric risk/reward for those who can stick with investments through long periods of time.
  4. Some argue that recent SEBI regulations on mutual fund holdings will erode alpha. Only time will tell if that is true because of (1) and (2).
  5. Under-performance is not permanent. See ICICI’s fund below.

ICICI midcap mutual fund

What we see here is that at least in the midcap space, funds have been able to outperform the index in the past (both recent and distant.) However, that is no guide to the future.

Notes:

  • The total-return index doesn’t go back long enough to be used for this analysis.
  • The risk-free rate used was the 0-5 year YTM adjusted for the weekly time-series.

Code, charts and time-series alpha, beta and IR for about a dozen mutual funds that are over 10-years old are on github.

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Tax Drag on Compounding

The long-term capital gains tax on equity returns of 10% may not seem as much but it makes a huge difference if you are one of those “long-term” mutual fund investors who switch funds every year. To think through the effect of the tax on compounded returns, imagine a simple scenario where you invest in the midcap index and just sell and buy it back at the end of every year. In this hypothetical scenario, from the year 2002 through now, gross returns of buy-and-hold would have been 2245% vs. 1754% after tax. That’s ~22% of profits gone poof.

after tax midcap 100 returns

Will mutual fund investors be better behaved given this new normal?

Code and more charts on github.

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Should You Buy What Mutual Funds Buy? [Update]

Back in November-2015, we had concluded that it does not make sense following mutual fund entries and exits from individual stocks. Using an expanded data set of 260 funds, we still reach the same conclusion. Median returns over 10, 20 and 50 days on additions were 0.49%, 1.81% and 4.88% whereas exits clocked -0.01%, 0.90% and 3.27%.

Direct equity investors would do well to ignore what fund managers a doing.

Code and results are on github.

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Mutual fund portfolio overlap and Active Share

There is a problem of plenty when it comes to mutual funds – direct growth schemes alone number into the high 200s. Investors have responded to this bewildering array of choices by going in for the ‘unlimited buffet’ option. They end up making small investments into a large number of funds. By doing so, they end up owning the whole market – paying active management fee for a passive investment. There are two things investors should keep in mind before adding a new fund to their investment:

  1. What is the new fund’s portfolio overlap with the existing investments?
  2. How different is the new fund’s portfolio from a large-cap and mid-cap index?

The first answer will tell you whether to add the new fund to your portfolio. The second will tell you if you should just replace the fund with an index ETF.

For example, say you own HDFC Mid Cap Opportunities and you are wondering if you should also buy the Birla Sun Life Midcap fund. Here’s how the fund portfolios overlap:

The funds have about 18 stocks in common and a fairly large number of stocks that are not in any of the indices. Given the differing styles, perhaps it makes sense to add the new fund to the portfolio.

The second, also called “Active Share,” shows how different the portfolio is from an index. For example, DSP Blackrock Technology.com Fund has a 26% overlap with NIFTY 100 and a 5% overlap with NIFTY MID100 FREE. Whereas, the HDFC Large cap Fund has a 95% overlap with the NIFTY 100 index. It probably makes sense to replace the latter with an index fund.

For more details about the analysis and its results, please peruse the notebook on github.

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Replacing Mutual Funds with ETFs

Last month, we took a stab at measuring a fund’s alpha over a basket of ETFs (link.) The rationale was that the index often chosen by the mutual fund is not easily accessible to the investor. We saw how mutual fund alpha varies over time. We then asked the question: What if we just invested in the basket instead of buying the fund?

We did a study of the top 10 equity mutual funds by AUM back in March-2011 and found that 4 out of 10 funds under-performed their ETF baskets and 2 out of 10 funds could be replaced by an ETF basket without compromising too much on returns. That is, only 4 out of 10 fund out-performed the ETF basket setup for them.

The code, inputs and results are on github.

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