net assets under management mutual fund home in india 35.6 trillion, by 30 June 2022. At 12.86 trillion, equity-oriented schemes contribute 36% of the total assets under management. This significant portion of assets under management is actively managed. Fund managers with better skills are expected to outperform the benchmark portfolio index funds Which replicate those benchmark portfolios.
Although investors trust the competence of fund managers, there is overwhelming evidence that actively managed mutual funds underperform the benchmark and their passively managed counterparts.
When an investor invests in a fund that is actively managed, it is expected that the fund’s performance will outperform the benchmark. To outperform the benchmark, the fund manager has to break away from the benchmark portfolio.
The fund manager is required to build and manage a portfolio that is somewhat different from the benchmark portfolio in terms of securities and weightage, utilizing his securities selection skills. The fund needs to be managed as per regulatory requirements.
For example, as per the Securities and Exchange Board of India’s (SEBI) October 2017 circular on classification and rationalization of mutual fund schemes, large cap funds are required to have a minimum of 80% investment in equity and equity related instruments of large cap companies . ,
Large cap companies are defined as the top 100 companies in terms of absolute market capitalization. The fund manager needs to comply with these requirements.
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Yale professors, Kramers and Petajisto have developed Active Share as a way of quantifying active management. Active Shares measures how well a fund’s portfolio differs from the benchmark index.
The range of active stake is from 0% to 100%. In terms of 0% active share, the fund is similar to the benchmark. Theoretically, an index fund is designed to have an active stake of 0%. If the active share is 100%, it means that the portfolio is completely different from the benchmark.
Conceptually, the higher the percentage of active shares, the more “active” the manager is.
Generally, funds with more than 50-60% active share are considered to be reasonably actively managed. The lower the active share, the closer the fund is to the benchmark portfolio. Such funds are similar to index funds and may be called “closet index funds.”
The table shows the active share of 20 Large Cap Funds for top 10 holdings as on 30 August 2022 as compared to Nifty 100.
The benchmark of all these funds is Nifty 100. As can be seen from the table, the fund’s top 10 holdings form a significant portion of the fund’s investments.
In some cases it is up to 74 per cent. In the case of Nifty 100, the top 10 holdings constitute almost 50% of the portfolio. Active shares range from 9.46% to 58.20% based on top 10 holdings. Funds with fewer active shares are closely following the benchmark of their top 10 holdings.
However, high active shares are no guarantee of outperformance as the active share metric is only an addition to the toolkit for evaluating actively managed portfolios, low active shares certainly helps in identifying Closet Index funds i.e. Funds that claim to be active, but are, in fact, very similar to indices.
Investors would be better off investing through low-cost index funds pegged to the same benchmark index, rather than these active funds that hover around a benchmark portfolio but come with a high expense ratio.
For long-term investors, these options make sense, as the savings on expenses are certain while the outperformance is not!
Dr Rachna Baid is Professor – School of Securities Education, National Institute of Securities Markets (NISM). The views expressed here are personal.
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