Value Research data shows that many large cap funds have underperformed their benchmark over the last one year.
While there is no denying that one year is too short term to analyse performance of any large cap fund, passively managed funds deserve your attention especially in the large cap space where outperformance gets difficult with introduction of Total Return Index (TRI) index.
Let us look at why passive funds make sense in large cap space especially during markets like this:
The performance benchmark
From 1st Feb 2018, fund houses started benchmarking their schemes against the Total Return Index (TRI).
Unlike traditional benchmarks, which do not take into account dividend income, TRI includes interest, capital gains, dividends and distributions realized over a given period of time. Simply put, TRI takes into account the dividends from companies, which is reinvested. Hence, TRI provides an apt measure to reflect the true alpha created by mutual funds.
Large-cap funds are thus finding it challenging to beat the benchmarks. The recent trends show a reduction in the number of large-cap funds that outperform the index. Also, the margin of outperformance has witnessed a decline.
Advantages of low cost investing
Passive funds offer the benefits of low cost investing. The most reasonable ETF is normally available at 10 basis points as against the usual 1%-1.5% of its active counterparts.
Assuming a scenario where the active funds have clocked 1%-2% more returns than the benchmark, the investor may not reap the entire benefit owing to the high costs. Hence, cost-effective ETFs can result in higher net returns over the long term.
A narrow market rally
The recent past showed market rallies that were confined only to the performance of a few stocks. With a handful number of stocks driving the index higher, many actively managed large cap funds underperformed the benchmark.
The reason for underperformance is structural in nature– adequate flow of funds in index funds and ETFs from institutional players and narrow market rally. In narrow rally, only few stocks drive performance of index. Actively managed funds cannot have a concentrated portfolio, as they are not allowed to invest more than 10% in single stock.
