Why do people invest in actively managed funds when there is overwhelming evidence to support that actively managed funds are unable to consistently outperform their benchmarks?
According to the recently released S&P Indices Versus Active Funds (SPIVA) Scorecard,[1] in the first half of 2020, the majority of the actively managed equity funds in the Indian Equity Large-Cap and ELSS categories lagged their respective benchmarks. In the second half of 2020, the asset-weighted returns were lower than their respective benchmark returns in each of the Indian Equity categories: large-cap funds (by 273 bps), ELSS funds (by 318 bps) and mid- and small-cap funds (by 230 bps).
Over the one-year period ending in December 2020, 80.65% and 65.12% of the Indian Equity Large-cap funds and ELSS funds, respectively underperformed their benchmarks. This underperformance is not just limited to equity funds. Actively managed bond funds have also overwhelmingly underperformed their respective benchmarks over the 6-month, and 1-, 3-, 5-, and 10-year periods.
But then, you must be wondering, if the best of the fund managers are unable to consistently beat benchmark returns then what hope do you have? The good news is that you have some really great options.
The active management strategy is focused on stock selection. Fund managers actively buy and sell stocks in an attempt to beat benchmark returns. However, as we have seen, most actively managed portfolios do not meet this goal. At the other end of the spectrum is the passive management strategy that is focused on generating benchmark returns by buying stocks that comprise the benchmark index and holding them in the same proportion as the index. Since passive portfolios mirror the benchmark index in terms of composition, their returns also mirror index returns (adjusted for tracking error and minimal fund management fees). While passively managed funds might be a good addition to your investment portfolio, they cannot completely meet all your portfolio requirements.
It is time to get smart about your investments.
An investment strategy offering an optimal middle path is the smart beta strategy. These strategies aim to maximise returns while minimising risk. Smart beta strategies primarily follow a passive strategy but with a twist. They actively change the weighting of the stocks in the portfolio based on select factors like volatility, momentum, value, and quality. This means that fund managers who follow the smart beta strategy tend to give a higher weight to stocks that comply with their chosen factors. For example, a smart beta portfolio that is focused on the momentum factor will give a higher weightage to stocks that have high momentum, i.e., are well-positioned to capture price trends and generate excess risk-adjusted returns over the long-term. As a result, smart beta strategies are able to enhance returns while passively replicating benchmark or select indices.
In a world where active strategies are not worth the risk that you pay for and passive strategies are not able to meet all your portfolio imperatives, WealthBaskets that follow the smart beta strategy can be an ideal investment choice.
