S&P Dow Jones Indices has been leading the active versus passive fund debate with its SPIVA (S&P Indices Versus Active Funds) scorecard published in various countries. Akash Jain, Associate Director, Global Research & Design, S&P Dow Jones Indices, responsible for the latest SPIVA India scorecard, in this exclusive chat with BusinessLine, talks about the relevance of this report in India.
Can you give a small background to the SPIVA report and its methodology?
This is a global report published in many countries, including the US, Canada, Australia and Japan. It’s a bi-annual report where we try to compare active funds with their benchmarks. The SPIVA can be defined as an objective score-keeper in the active versus passive debate, where our objective is to help investors take more informed decisions in the market.
To ensure that the methodology is consistent across the globe, we pull all the funds in the Morningstar database, which is an independent third party data-base. We get the funds’ assets under management from the AMFI website. Using these two, and the Morningstar classification of funds, we put the funds in five buckets — large-caps, ELSS, mid- and small-caps, government bonds and composite bonds. Once this is done, we identify the funds that survived the investment horizon before comparing their performances with the benchmarks.
So what are your findings about the Indian mutual fund market?
We found that in 2016 — between January and December — 66 per cent of the large-cap funds have under-performed their benchmarks. In the mid and small-cap space, almost 71 per cent of the active funds have under-performed their benchmarks in the one-year horizon. The under-performance of active funds in the ELSS bucket was 64 per cent, in government bond funds it was 36 per cent and in Indian composite bond funds, it was 82 per cent in the one-year period. The performance varies depending on the time period considered.
Style consistency is one of the metrics you consider while evaluating the relative performance. Can you explain this?
We look at this to see if the fund has changed its benchmark or deviated from its initial strategy of investing. For instance, if a fund set up to invest in large-caps moves into flexi or multi-caps, that would be a change in style.
So what does this metric indicate regarding Indian mutual funds? From our observation, Indian mutual funds keep changing their mandates…
Just to highlight the importance of this, globally too, style consistency is considered an important metric for asset allocation decisions; it helps in making an investor understand the risk and returns in an investment. In the large-, mid- and small-cap segments, we have seen low style consistency over the last 10 years. If you see the latest SPIVA report on India, you can see that over the last 10 years, only 30 per cent of large-cap funds have shown a consistent style of investment. In mid- and small-cap equity funds, too, style consistency is quite low at 28.5 per cent. ELSS funds have shown the highest consistency with their mandates, with style consistency over a 10-year period at 96 per cent.
There is this thought that there are still opportunities in the developing markets that are less efficient when compared to the developed markets, which active funds can exploit. What is your take on that?
The margin of out-performance in developed markets is very narrow whereas in Indian markets, as we go down the pecking order in market cap, the out-performance increases. For instance, the extent of outperformance is greater in small-caps when compared to large-cap funds.
The SPIVA report also shows that the outperformance of the large-cap funds over their benchmarks increases when the funds are asset weighted, as compared to equal weighted returns. This means that funds with higher assets under management have managed to deliver better returns when compared to smaller funds.
Any views on how passive funds perform in various parts of the market cycle?
As a follow-up to the SPIVA report, I looked at the large and mid-cap space and whether outperformance is consistent or is in specific periods only. We noticed that active funds outperform in bear markets and modestly in bull markets but in recovery markets they record relative under-performance.
It will be worthwhile to look at how we define a bull, bear and a recovery market first. A recovery market is from the bear market low to the next 12 months, a bull market will be from the 13th month to the bull market top and bear market would be the peak to trough.
In a recovery market, as stocks reverse from a bearish phase, funds are invested in low-beta stocks or cash allocations are higher, resulting in under-performance.
What are smart beta indices?
Smart beta lies in combining various factors that explain risk-return characteristics in a portfolio. Typical factors will include size, volatility, momentum, dividend or value. In the past, many fund managers have used these parameters indirectly to pick their portfolios. We have back-tested various factor indices in the Indian context. We looked at factors such as risk-adjusted momentum, volatility, value and quality. These are single factor indices that were launched in 2015.
Do you think that in the Indian context where governance risks are higher, it is possible to automate the investment decision completely through passive investing?
To address that, we have the quality index where we look at a company’s accrual ratio, ROE and leverage. We pick the best quality stocks from the top 160 stocks listed on the BSE. The idea is that when we finally evolve to smart beta, we can combine more than one of these factors to create a multi-factor index. For instance, you could create a quality and value index combining the two.