Mutual Funds
Mutual funds and randomly walking monkeys
The often ignored disclaimer, "past performance is not an indicator of future results" is very important for mutual fund investors. A fund that looks the best based on its past performance may not turn out to be the best in the future
 
In 1973, Burton Malkiel, a professor of economics at Princeton University, made an astonishing claim in his best-selling book ─ A Random Walk Down Wall Street.  He claimed that a blindfolded monkey throwing darts at a newspaper’s financial pages could select a portfolio that would do just as well as one carefully selected by experts. The implications were profound. It meant that professional fund managers do not create any value for the investors. Unsurprisingly, it was fiercely opposed by the investment professionals and has since been a source of a long-standing debate. 
 
This idea, also known as the random walk theory, suggests that stock prices evolve randomly, and therefore, cannot be predicted. If this were true, professional fund managers would have no informational advantage over the retail investors. Consequently, fund managers would not display superior skill in either selecting the best stocks or in timing the markets. In fact, the proponents of the random walk theory believe that the equity investors are best served by investing in low-cost index funds and exchange-traded funds (ETFs) that provide returns similar to that of the overall market. On the other hand, the mutual fund industry claims to achieve higher returns than the traditional investments. The past performance of equity mutual funds is regularly compared against market benchmarks such as the Nifty and the Sensex, often with mixed results. Some funds underperform the market, whereas others provide better returns than the market benchmarks.
 
It is easy to identify a mutual fund that gave much higher returns than the market in the past one year or five years. Moneycontrol.com provides a free tool to find the top-performing mutual funds for the last five years. Consider an investor who would only prefer to invest in the best performing funds. The table below looks at the top performing equity mutual funds at different time horizons, as on 8 February 2016.
 
 
The best-performing equity mutual funds comfortably outperform the Nifty index. But should you invest in these funds? Careful readers would notice that it is not straightforward to choose the funds based on such an analysis. The choice of the best fund would depend on the time horizon you choose. In the last six months, arbitrage based equity funds have performed the best. In the last two years, funds based on small-cap and micro-cap stocks have performed the best. If your horizon is the last five years, the best equity funds have been the ones that have focussed on a specific sector, such as pharmaceuticals and logistics. Moreover, there is little overlap between the different time horizons, which suggests that even the best funds do not consistently outperform all others. 
 
The often ignored disclaimer ─ “past performance is not an indicator of future results” is very important for mutual fund investors. A fund that looks the best based on its past performance may not turn out to be the best in the future. On the other hand, if a fund manager is really skilful, the fund should be able to generate consistently high returns. Can someone outperform the market simply by being lucky? Absolutely! Note that the return of the overall stock market is a weighted average of the returns of all the individual stocks. As a result, in any period, some stocks would fare better than the market, whereas others would perform worse than the market. 
 
Now, consider a mutual fund manager who constructs his portfolio completely randomly, that is, without any investment skill whatsoever. If he happens to allocate more capital to the stocks that do better than the market, simply by chance, the mutual fund would perform better than the market. Conversely, if he allocates more capital to the stocks that do worse than the market, the mutual fund would perform worse than the market. So the past performance of the mutual fund is not necessarily an indication of the skill of the fund manager, but it may simply be a matter of chance. It is important to distinguish between luck and genuine investment skill, because a fund that performed well due to superior investment skill is more likely to repeat its high level of performance in future, unlike a fund that performed well only due to luck.
 
Our recent study ─ “Testing the skill of mutual fund managers: Evidence from India” attempts to test the skill of Indian equity mutual fund managers. Our findings suggest that the performance of Indian mutual funds is highly inconsistent. For example, we find that the best performing mutual funds (top 25%) for a particular month have a 35% chance of being the best performers in the next month. However, they also have a 31% chance of being the worst performers (bottom 25%) in the next month. 
 
In other words, a best-performing fund of the current period can turn out to be to be the best or the worst performer in the next period with an almost equal probability. To test the skill of equity mutual fund managers, we took a cue from Malkiel’s idea. We simulated a large number of monkeys by generating 10,000 randomly created portfolios with all the stocks listed on the National Stock Exchange (NSE). Then, we compared the performance of equity mutual funds with these “monkey portfolios” over a long horizon (from 1 January 2003 to 31 July 2014). Surprisingly, the average mutual fund did not perform any better than the average monkey portfolio, whereas the best monkey portfolio fared much better than the best mutual fund. 
 
Finally, it can be argued that the retail investors benefit from the diversification provided by the mutual funds. This is true, however, exchange traded funds can be used to achieve portfolio diversification with much lower fund management charges than those of the equity mutual funds. 
 
(Prateek Sharma is Assistant Professor of Finance at IMT, Ghaziabad)

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COMMENTS

Ramesh Poapt

9 months ago

2016 so far is not good for Eqty funds.Balanced funds may have some solace. A recent category of fund which is slightly riskier than MIP us Eqty saver funds,which benmarked as 30% nifty or 25%MIP blended,here benifit is it is eqty oriented fund and debt oriented fund like MIP.
Asset al;location,risk profile and time horizon plays important role.Staggered(SIP/STP)investment is other important tool.

RAVI RAM PV

9 months ago

For choosing the safe option of Index ETFs: Problem is that in India ETFs are not as easily to buy and sell. I had burnt my fingers buying the Bees which is the country's largest ETF. Both ways - buy n sell - there was loss, as the market value did not reflect the NAV.

India's economy haven of stability amidst global turbulence: President
New Delhi : Noting India recorded its highest foreign exchange reserves in 2015, President Pranab Mukherjee on Monday described the country as a haven of "stability" in a turbulent global economy, saying it has put in place a non-adversarial tax regime to attract investments.
 
"India is a haven of stability in an increasingly turbulent global economy. GDP growth has increased making India the world's fastest growing economy among large economies," he said in his address to the joint sitting of parliament at the opening of its Budget session.
 
"Inflation, fiscal deficit and current account deficit have all decreased. India recorded the highest ever foreign exchange reserves in 2015," he said.
 
"Innovative initiatives have helped India jump up 12 places in the latest rankings by the World Bank on ease of doing business," he added.
 
On the government's initiatives towards an investor-friendly tax regime, Mukherjee said: "The government has taken a number of measures to put in place a simplified, progressive and non-adversarial tax regime by incorporating internationally prevalent best practices in tax administration."
 
He said the government is engaged in reforming institutions, simplifying procedures and repealing obsolete laws, apart from unlocking infrastructure development opportunities and cutting subsidy leakages.
 
Besides, procedures have been simplified to improve ease of approvals, and dedicated commercial courts and commercial divisions in high courts have been established.
 
"For speedy resolution of commercial disputes, the long overdue amendments to the Arbitration Act have been made," he said.
 
Employment is being generated through initiatives like Make in India, Startup India, Mudra scheme and Skill India, he added.
 
On agriculture which has suffered two successive seasons of inadequate rainfall, the president said the government was keen to fully harness the agricultural potential of eastern states and steps had been taken to usher in a second Green Revolution.
 
An e-marketing platform was being created to connect all regulated agricultural markets.
 
The president also informed parliament that the country recorded the highest-ever software exports during 2015, while the IT modernization project involving computerization and networking of 155,000 post offices in India will be completed by 2017.
 
Disclaimer: Information, facts or opinions expressed in this news article are presented as sourced from IANS and do not reflect views of Moneylife and hence Moneylife is not responsible or liable for the same. As a source and news provider, IANS is responsible for accuracy, completeness, suitability and validity of any information in this article.

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COMMENTS

Gupta

9 months ago

We are certainly a "haven of stability" because we are still way behind the rest of the world. Everybody else is at 30000 feet and in a bad weather, they will obviously face some turbulence. But no one is falling to Earth. However, our plane is yet to take off. Obviously, the bad weather is not impacting us. Time to stop chest thumping and laughing at others because "others are weak" and time to do something to make "ourselves stronger".

Maruti Suzuki resumes production at Haryana plants
New Delhi : Automobile major Maruti Suzuki on Tuesday announced that it has resumed production at its facilities in Gurgaon and Manesar.
 
The company had to temporarily suspend manufacturing of vehicles at its flagship facilities in Manesar and Gurgaon on Saturday, due to the transport and other disruption caused by the Jat community's quota agitation.
 
"Maruti Suzuki India has resumed production of vehicles at its facilities in Gurgaon and Manesar, starting Tuesday, February 23 (second half). The supply of components has started gradually," the company said in a regulatory filing with the BSE.
 
"The company had to suspend operations at its facilities from Saturday, February 20 (second half), as supply of certain components was disrupted due to the agitation in Haryana."
 
Currently, the combined output of Maruti Suzuki from Manesar and Gurgaon plants is about 5,000 vehicles per day.
 
Haryana's Jat community, wanting affirmative action, had started a state-wide agitation. 
 
The protests and violence accompanying them adversely impacted various companies' ability to get supplies, or ship out their merchandises.
 
The Jat community's quota agitation even crippled rail and road transport to and from the national capital to Haryana, Punjab and Rajasthan.
 
Disclaimer: Information, facts or opinions expressed in this news article are presented as sourced from IANS and do not reflect views of Moneylife and hence Moneylife is not responsible or liable for the same. As a source and news provider, IANS is responsible for accuracy, completeness, suitability and validity of any information in this article.

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