The Indian mutual fund industry has delivered exceptional alpha over the last two decades across multiple categories be it equity, debt or hybrid funds.
CII and Mckinsey report ‘India Asset Management – Coming of Age’ said that an investment of Rs. 10,000 in equity mutual funds (represented by the CRISIL-AMFI Equity Performance Index) would have grown by 29.2 times compared with 14.9 times by Nifty 500 (TRI) index generating an alpha of 4.22 percent per annum over the last 19 years. Meanwhile, an investment of Rs.10,000 in hybrid mutual funds would have grown by 13.5 times compared with 8.5 times by the Hybrid Aggressive Nifty 500 Index generating an alpha of 3.34 percent per annum over the last 16 years.
Moreover, the report shares that as per CRISIL’s research, debt funds too outperformed their benchmarks and bank deposits.
Is the trend sustainable?
Globally, the trend points towards reduction in alpha. The report said that 99 percent of actively managed US equity funds sold in Europe have failed to beat the S&P 500 over the past 10 years. The shrinking alpha has led to shift in asset allocation from active to passive funds.
Why has alpha disappeared in developed economies?
To explain this, the report refers to William Sharpe’s (he is a professor of finance and winner of the Nobel Prize) explanation on the subject. According to William, alpha is a zero-sum game. What it means that in a market, all active managers put together cannot make more returns than the market return. If one manager is making more return and alpha then someone else is losing. Generally, in a market, it is the amateur or retail investors who lose money while the more professional and institutional investors such as mutual funds make money. This leads to retail investors investing through mutual funds. As a result, the active funds become more and more competitive with professional investors in play. Overtime the marketplace becomes fully institutionalised and more efficient.
As the individual ownership has declined sharply in developed market over the years, the alpha generation capabilities of mutual funds have also
declined.
Where does India stand?
The report said that India is today the size of MF industry of the US in 1989. It also has a high level of direct ownership of stocks by individuals. To evaluate the penetration of the MF industry and thereby institutionalisation of the markets, the report compares the AUM to GDP or market cap of the country. In 1989 in the US, MF AUM was around 5% of its GDP, a level that Indian MF industry reached in 2013. By 2006, the MF industry in US grew to 80%. Consequently, India’s current MF AUM to GDP ratio would need to rise to 80% from the current 12% to make it a fully institutionalised market, says the report.
The report concludes that it would take India another 10 to 15 years to become a predominantly institutionalised market for aggregate alpha of industry to shrink. This period would also witness significant growth opportunities across market capitalisation and across sectors for the industry to sustain alpha over the next decade at least.
