Get a taste of passive funds via a large cap fund

The latest SPIVA (S&P Indices versus Active) scorecard for India (for end of 2022) is out. It shows that 87.5 per cent of large-cap funds, 76.9 per cent of ELSS (equity-linked savings schemes) funds, 54.9 per cent of mid- and small-cap funds, 45.4 per cent of composite bond funds, and 68 per cent of government bond funds have underperformed their benchmarks over the preceding one-year period.

- Sudipta Mitu

In case someone argues that this is a one-off period of underperformance, the long-term results also bear out the same trend. Over a 10-year period, 67.9 per cent large-cap funds, 63.4 per cent ELSS funds, 50 per cent midand small-cap funds, 98.2 per cent composite bond funds and 82.9 per cent government bond funds have failed to beat their benchmarks. In the light of such data, investors need to think of allocating a part of their portfolios to passive funds.

Besides a large proportion of active funds in most categories underperforming their benchmarks, investors face another major impediment when they try to select an active fund. If you consider successive blocks of 10 years, the set of funds that outperform in one block is not the same as the set that outperforms in the next block. In other words, the winners keep changing from one decade to another. This makes it impossible to select funds, based on past performance, that will outperform in the future.

Avoid fund manager risk In an active fund, the investor is exposed to fund manager risk. If the fund manager picks the wrong stocks or goes overweight on the underperforms and the wrong sectors, his fund investors in his funds suffer.

Fund manager risk manifests itself in one more way. Suppose that you select a fund based on its past performance because you believe its fund manager, who has performed in the past, will continue to do so in the future. However, it is quite possible that after you have entered the fund, the winning fund manager quits that fund house and moves to another. That creates a dilemma: do you stick to the same fund or move to the new fund that the fund manager is now managing? And what if you like the fund manager but are sceptical about investing with the new fund house that he has joined?