THE long-standing claim by fund managers that actively-managed equity schemes tend to outperform index funds over a longer period, may no longer hold water. The performance data of these schemes over the past three years show that index schemes have performed better than equity diversified peers.

In fact, mutual fund industry managers and watchers expect the superior performance of index funds to continue, going ahead, as the stock market turns more efficient and funds grow big enough to identify sufficient
‘multi-baggers’.

Index funds are passively managed and comprises a portfolio, which tracks and mirrors the components of an index. Diversified equity schemes are actively managed by fund managers. They argued that active fund management had the scope for outperformance because the relatively inefficient market gave them enough opportunities to gain from aberrations. In the bull market, the identification of a ‘multi-bagger’ — mostly a mid-cap stock, which doubled or trebled over a period — usually gave them that edge to perform better. But as recent market conditions were not conducive for picking a multibagger, returns from diversified equity funds lagged the index schemes.

An analysis by Benchmark Asset Management of 60 large-cap diversified schemes shows only 5-7 schemes have been able to perform better than index or exchange-traded funds. According to Value Research, a New Delhi-based mutual fund tracker, equity diversified schemes returned 9.19% over the past three years, while the Sensex and Nifty returned 11.71% and 12.25% in the period.

“This trend will continue because even as market evolves the skills of fund managers, relatives to markets are deteriorating,” said Benchmark AMC ED Sanjiv Shah.

The outperformance of index funds vis-à-vis actively-managed funds is a global trend, especially in developed markets like the US. In fact, several investors there are shifting a chunk of their money to passively-managed funds.

Domestic fund managers said the constant churn in equity schemes by investors is one of the constraining factor for the performance of actively-managed funds.

“If we were to follow the Warren Buffet style of investing (sell at higher levels, hold cash and invest at lower levels), then there is scope,” said a fund manager with a leading private mutual fund.
Benchmark believes controlling of costs (index funds — 0.5% a year and active fund — 2.5%) can partly reduce the level of underperformance of equity schemes.

“This difference of 2% per annum can balloon into huge difference over a number of years because of compounding. In the moderate return environment, it becomes a significant portion of your returns,” the Benchmark analysis said.

After the capital market regulator’s decision to abolish entry load for mutual fund schemes, it’s now time for the insurance regulator to usher in reforms, says Monika Halan.

There shall be no entry load for the schemes, existing or new, of a mutual fund. The upfront commission to distributors shall be paid by the investor to the distributor directly. The distributors shall disclose the commission, trail or otherwise, received by them for different schemes/mutual funds which they are distributing or advising the investors (on).”

The short 55-word decision from the capital market regulator, the Securities and Exchange Board of India (Sebi), that abolished the upfront agent commission (currently you pay up to Rs2.25 on every Rs100 invested in a mutual fund) has created havoc in the market. Breast beating or the clink of bubbly glasses depends on who you are—a mutual fund or an insurance agent

Commission bearing financial products, such as mutual fund schemes and insurance policies, run the risk of misselling by vendors who push products that maximise their incomes, rather than client welfare.

By taking away the incentive to push the fund that gives the most commission, Sebi’s decision will nudge the market to eventually split into chemists and doctors. The chemist will simply vend mutual fund schemes and offer no opinion on what you should buy. You will probably come to him for ease of transaction and for that, not unlike the payment to your stock broker, you will pay anything between 20 paise and 40 paise on every Rs100 of transaction

Undiverted by the din of the new fund offer sales spiel that threw money at distributors to sell their new fund offers (there are stories of large distribution houses not even taking calls from new fund houses unless a 4% commission was on the table), you will now look very carefully at past performance, track records and annual fund management fees before you buy

And no, you will not cut a cheque for 20 bucks each month you buy, as some fear, you will probably pay for this through an annual cheque for the service or an on-line payas-you-go system, not unlike the stock broking model that you are used to

What if you don’t want to do the homework and would rather have advice from a professional? To get this, you will not go to a chemist (like you do currently) but to an entity that has the ability to offer financial advice. Which means, the adviser has a set of attributes in terms of a basic level of education and certification and is in a regulatory framework that allows you to trust his credentials. For this, you must be willing to pay an annual fee to the financial adviser, who may also vend the products himself or have tieups with pure vendors.

The adviser will be a tracked entity with a paper trail on the advice he gives, and will not be able to suggest a unit-linked insurance policy to a person seeking a pension product and get away with it.

He will run the risk of his livelihood—his licence— being cancelled
With this 55-word decision, we are closer to this superior way of managing the retail flow of money into the markets

A key reason that India remains stuck at low levels of household participation in financial instruments and invests still in low real return bank deposits, is the lack of trust in the product vendor – and rightly so
You make smart choices—if you can’t trust the guy selling, you simply don’t buy the product.

For this market to work, there is yet a couple of missing links. The separation of advice from vending or of a doctor from a chemist is yet to happen. Given the fact that any product bearing a load (cost or commission) has advice embedded in it, the surgery to separate the two must happen. Sebi has done it

But one part of the market is so much in the dark ages that unless the winds of reform blow in Hyderabad (where the insurance regulator resides), you will continue to be mis-sold products and the retail market will remain small, under-developed and inefficient. The insurance regulator, compared with its capital market counterpart, is still grappling with the past. Not only are commissions embedded in the product, but are actually pushed together and collected from you in the first three years, on a product that is supposed to live for at least 15

Some of these agent com- missions are hidden away in a head called “administrative costs” that you don’t even see

So, you pay for the joy of buying a 15-year product (that you may be encouraged to churn after three years) and pay up to Rs40 on Rs100 invested, (remember we are now talking of 20-40 paise in funds for the same investment!) and worse, you continue to pay the agent a commission over the life of the product that is unlinked to the service you get. In the new post-Sebi no-load decision that is asking you to evaluate the service and pay for it, the contrast seems even starker

Where we go from here will depend on what the insurance regulator does now. The need is for drastic reform and to separate advice from product vending, and of course, to not fall back on either the limitations of Insurance Act or the global precedents of the life insurance industry

And also throw out the glib story that some smart insurance chief executive officer gave it eight years ago that the industry needs leg room to innovate hence the non-standardization of costs, lack of benchmarks and lack of control of the customer to evaluate and pay for the service of the agent
If freedom was what it took, then surely after more than 50 years of insurance vending in the country, penetration would be higher than the current under 5%. The move is now from Hyderabad and the Indian retail investor is hoping that it plays ball