A high percentage of equity schemes were closed or merged over the past five years. Despite adjusting for survivorship bias, over 75% of equity schemes outperformed the benchmark
When the average returns of mutual funds are touted, they are of funds that exist over the entire period of study. That is, it is a return of the survivors. What about funds that are closed or merged during the period? How does that affect average returns? Since it is impossible to know at the start of the period which schemes would survive and which won’t, it is important to take into account the returns of all the schemes that were there at the start of the period and then arrive at average returns. This is called survivorship bias free returns. However, despite eliminating survivorship bias, a majority of equity schemes outperformed the selected benchmarks.
S&P Dow Jones Indices has done exactly this, especially since over the past five years, many mutual funds were merged or liquidated. In a research titled—“SPIVA® India Scorecard”, Standard & Poor's Indices Versus Active (SPIVA) reported that the survivorship rate of equity mid-and small-cap schemes over the one- and three-year periods was close to 91%, but it reduced drastically to 70% over the five-year period. Over the five year period as many as 16 of the 53 mid-and small-cap schemes at the start of the period were merged or liquidated.
Reporting the fund performance of the industry, SPIVA Scorecards account for the entire opportunity set—not just the survivors—thereby eliminating survivorship bias. Large-cap schemes reported poor benchmark related performance compared to other category of equity schemes. Some 76% of the 105 large-cap equity actively managed schemes outperformed the S&P BSE 100 over the one-year period. This drastically reduced to 42% and 47% over the three- and five-year periods, respectively. All index returns considered in the report are total returns, that is, they include dividend reinvestment.
In the mid-and small-cap category, more than 89% of active schemes in this category outperformed the S&P BSE Mid Cap over the one-year period. Over the three- and five-year periods, 78% and 64% of the active schemes outperformed the benchmark respectively.
Equity linked savings schemes (ELSSs) had the highest survivorship rate, more so, because these schemes have a lock-in period of three years. In terms of performance, 95% of ELSSs outperformed the S&P BSE 200 over the one-year period, which reduced to 86% and 69%, respectively over the three- and five-year periods. The lock-in period is advantageous for fund managers, the quantum and frequency of inflows and outflows would not be as much as the other open-ended category of equity schemes.
The report says, “Over the five-year period, active funds in the Indian ELSS and Indian Composite Bond peer groups maintained a healthy survivorship rate of 97% and 94%, respectively. Close to 20% of the active funds could not survive in the Indian Equity Large-Cap and Indian Government Bond peer groups over the same period. Also for the five-year period, the survivorship rate in the Indian Equity Mid- and Small-Cap category was the lowest, at 70%.”
Mutual funds usually launch a high number of new fund offers during a Bull Market. Investors tend to get in when the market is rallying and fund houses look to capitalise on this behavioural bias. For example, as many as 92 equity schemes were launched over the one year period ended April 2014. Although most of the schemes launched in this period are close-ended schemes. Similarly, over the four year period from January 2004 to January 2008, as many as 165 equity schemes were launched. The schemes which are unable to gather an economically sustainable corpus or which have reported a poor performance are usually merged with other schemes.
This report considers just the past five year period for performance, hence it may not be representative of the true picture of the mutual fund industry as it considers point-to-point returns. In past we have highlighted the risk of choosing a wrong mutual fund scheme. It is important for investors to choose those schemes that have beaten the benchmark consistently over multiple periods.