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Fund managers faithfully follow the benchmark stocks, making it hard to separate luck from skill

Even the best funds tie up the bulk of their money to the heavyweight stocks of the benchmark, making it hard for investors to separate market performance from stock-picking skill

The popular perception of fund management is that investment experts pick stocks that either reasonably valued or have strong earnings growth ahead of them or both. Some also believe that fund managers are experts at buying and selling. While all this is sometimes true, the fact is that most fund managers are happy to pick the heavyweights of the underlying benchmark indices and sit tight. This often leads to two results. One, the portfolios look similar and two, they perform in line with the overall market. In technical terms, they deliver a lot of beta (market returns) not much alpha (returns from specific stock picking).

Take the case of some of the largest and best performing funds. The recent portfolio of Birla Sun Life Frontline had Reliance Industries (5.2%); ITC (4.9%); ICICI Bank (4.4%); Bharti Airtel (4.2%); Infosys (4.2%); Tata Consultancy Services (3%); Larsen & Toubro (2.9%) and HDFC (2.5%) as the top holdings. Now, you don’t need anyone to tell you that these are blue-chip stocks to buy and would do well for the long term. But there is another reason these stocks find a place in the portfolio of this scheme. They are heavyweights in the BSE 200, which also happens to be the benchmark of Birla Sun Life Frontline. Now look at another portfolio: Reliance Industries (6.5%); ITC (5.2%); ICICI Bank (4.6%); HDFC Bank (4.37%); Infosys (4.17%); Tata Consultancy Services (3.2%) and HDFC (3%) as the top holdings. The stocks are almost identical to the Birla scheme. How and why? This is the recent portfolio of Fidelity Equity Fund. These stocks find a place in the Fidelity scheme for the same reason. Fidelity’s benchmark is also BSE 200, so the portfolio is remarkably similar. The difference in performance between one scheme and another lies in the fact that weightages and cash levels are different in different schemes.

We are neither for, nor against, this approach of tying up the fortunes of the fund to the benchmark stocks and sitting pretty—but this creates difficulties for investors to assess performance.

If superior performance is coming from changing the weightages (position-sizing) and varying the cash levels (market-timing), investors can never separate out these two factors and while assessing performance. Under the situation, the only approach for investors is to have faith—that funds that have a consistent record of beating the benchmarks must be doing something right.

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COMMENTS

Nagesh Kini FCA

6 years ago

A message that is very aptly conveyed.
More of luck and less of skill!

sudindra

6 years ago

Do we have option of Short position in Mutual fund for the period upto 1 year..??????

We dont need fund manager to invest in those company stocks. I believe fund manager has to concentrate on all types of stocks in portfolio.

Sundaram

6 years ago

One more thought-provoking write-up from Mr.Basu.Thanks.

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