Active funds delivering alpha over long term- Report

Active funds delivering alpha over long term: Report

Actively-managed equity funds have shown a firm trend of delivering alpha over the longer term (10 years), according to a report by Kotak Institutional Equities.

The study reveals that 3-year and 5-year performance has also shown an encouraging trend of late. Analysts say besides healthy performance, the commission-driven distribution structure will also help limit passive substitution. HDFC MF and Nippon India are well-placed to benefit; returns will likely be driven by earnings growth.

Taking into account over Rs 20 trillion of active equity AUM, it was observed that ‘most active’ funds generated higher returns on an average, therefore suggesting that deviation from the benchmarks likely leads to better alpha for investors.

However, the share of top quartile (high active) AUM remains low at 20%, with 30% of the AUM in the bottom quartile. Active share refers to the extent to which a fund portfolio deviates from the benchmark both in terms of weights and stock selection. A fund with a high active share would imply that the fund manager is willing to differentiate against the market.

However, even as active management requires differentiating from the benchmark in order to tackle passive substitution, a highly differentiated position also runs the risk of performance being impacted, which could lead to market share loss.

The report was based on a sample of equity funds with overall AUM (assets under management) of Rs 14 trillion across major categories. Rolling returns (CAGR) at monthly frequencies were calculated across 1-year, 3-year, 5-year, and 10-year time periods.

Returns were covered starting 2003, but there was no coverage for funds merged/closed in the interim.

The report affirms that the industry has a strong track record of delivering alpha on a 10-year basis, with 70-80% of AUM beating benchmark returns (post-fee). For shorter durations, too, performance has seen a rising trend. The share of AUM outperforming on a five-year basis has improved to 55-60% (from 35-40% in September 2022) and to 45-50% (from 35-40% in September 2022) on a three-year basis.

Large-cap funds, too, are seeing a recovery in alpha, though midcap and flexicap funds are struggling, and smallcap performance is moderating owing to a high base.

This revival in performance is a positive for the industry, says KIE, given that the outperformance of active funds moves in cycles and is often influenced by dispersion and momentum.