Your Fund Portfolio

For a long-term investor to achieve stupendous returns (understood that this comes with risks), should the investor choose passively or actively managed funds? Are the Indian markets different from developed countries? Can an index fund beat actively managed funds? Are there any tools (like Morningstar) available to monitor the past performance of various mutual funds in India?

M Muthuraman

If achieving stupendous returns is your objective and you don’t mind the risks that come with it, it is best fulfilled by the category of actively managed small-cap equity funds.

For the last five- and 10-year periods in India, actively managed small-cap equity funds have delivered a CAGR (compounded annual growth rate) of 31 and 16 per cent, respectively.

For the same time frames, the market return (Nifty50 total return) was 12 and 8 per cent. The Nifty500, a broader market index, delivered total returns of 16 and 10 per cent, respectively.

Other categories of actively managed funds — large-, multi- and mid-cap funds — have delivered more moderate CAGRs of 10, 11.5 and 15 per cent, respectively, over the past 10 years.

If you would like to invest in small-caps, actively managed funds are your best bet for three reasons. One, India doesn’t yet have an index fund or ETF (exchange-traded fund) tracking the small-cap universe.

Two, unlike the large- or mid-cap segments, the scope for outperforming the index is quite high in the small-cap space.

Under SEBI’s new categorisation rules, while large-cap funds will be restricted to the top 100 stocks by market cap, and mid-cap funds to the next 150, small-cap funds can invest in the entire universe of stocks below the top 250.

Given the 5,000-odd listed stocks in India, the small-cap universe, therefore, offers the fund manager enormous leeway to add value through stock selection.

Three, while India has lately seen a large number of ETFs piggybacking on large- and mid-cap stocks, it doesn’t yet have a whole market ETF (like Russell 2000 ETFs in the US), or even an ETF focussing on small-cap stocks.

On the active versus passive debate, in the Indian context, a majority of the active funds have historically managed to beat Nifty50 and Sensex index funds/ETFs through fundamentals-based stock selection, avoiding stocks with governance risks, avoiding concentration in sectors such as financials, etc.

But as the variety of indices available, and passive funds piggybacking on them, expand, this could change.

Right now though, actively managed small-cap funds appear to be your best bet for high returns. Funds such as Franklin India Smaller Companies Fund and Reliance Small Cap are good choices.

Yes, Morningstar does have an India-specific fund database where you can look up the track record of all the prevailing schemes.

Send your queries to mf@thehindu.co.in

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