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  • Writer's pictureAkshay Nayak

SPIVA India Reports Decoded

The S&P Indices Vs Active (SPIVA) Scorecard report for a region is the primary source of information for a realistic assessment of mutual fund performance. It offers an unbiased comparison of the performance of actively managed mutual funds against their benchmark indices. It also provides an indication of the performance of passively managed index funds in that region. The report is released twice a year, on a semi annual basis.

The latest SPIVA India report available is the SPIVA India Full Year 2023 report. The report has found that the majority of actively managed funds significantly underperformed their benchmarks over 3, 5 and 10 year periods. This is in line with findings in SPIVA reports for every region where they are available.

This means that investors would be better off investing in passive index funds. But what are the major reasons why actively managed funds underperform their benchmarks? Why is the data given in the SPIVA report more reliable than most other reports that compare and analyse mutual fund performance? How should the data be interpreted? These are the questions I will attempt to answer today.

To set the stage, let us look at the benchmarks indices S&P considers when evaluating mutual fund performance within each asset class. A list of the relevant benchmarks have been given in the graphic that follows.

A brief explanation of the constitution and composition of each of these benchmarks is given in the graphic that follows.

Next, a quick overview of the major findings from the latest SPIVA India report. The SPIVA India Year End 2023 report found that 62. 1% of actively managed large cap mutual funds in India underperformed the benchmark over the 10 year period ended December 2023. During the same period 67.6% of Indian ELSS funds, 75.4% of Indian mid and small cap funds, 90% of Indian government bond funds and 99.1% of Indian composite bond funds underperformed their respective benchmarks. This is summed up in the graphic that follows.

The figures involved here may make the data look unreliable. But the data in any SPIVA scorecard report is the most reliable data available on mutual fund performance for two major reasons. Firstly, the data is corrected for and therefore free of something known as survivorship bias. The term survivorship bias has been defined in the graphic given below.

When applied to mutual funds, survivorship bias manifests itself in mutual fund performance reports. Most such reports only evaluate the performance of mutual funds that were in existence for the entire period of study. But this may not necessarily represent a true and fair evaluation of performance. A number of mutual funds may have gone out of existence during the period of study. And data on such mutual funds is not included in the results of most studies. SPIVA report data accounts for the performance of mutual funds that went out of existence during the period of study (if any) in each category. This effectively eliminates any survivorship bias in the data.

SPIVA reports also account for a persistence score. Where an actively managed fund in any category beats it's benchmark index in a given period, SPIVA reports check to see how consistently that particular fund has beaten the benchmark. It has been found that an actively managed fund that manages to beat its benchmark, only does so by a small margin. It has also been found that the outperformance is not consistent.

Now let us understand why all of this data represents a very weak case for investing in actively managed mutual funds. There are a few systemic factors that take any apparent performance advantage away from actively managed funds.

The first of these factors are the costs inherent to actively managed funds. The average actively managed mutual fund in India has a Total Expense Ratio (TER) of 2-3% per annum when offered under the regular plan. When offered under a direct plan, expense ratios may be in the range of 1% to 1.5%. Index funds on the other hand tend to have expense ratios of 0.2% to 0.3%. This differential excess of 1.5 to 1.8% in costs between actively managed and index funds drastically reduces investor returns over a long period of time (say 10, 15, 20 years).

Today, actively managed funds still account for the majority of assets managed by the mutual fund industry in India. This in turn means that the number of active fund managers would be high. This makes active fund management a highly competitive exercise. This may seem like a good thing. But actually turns out to be another factor that works against actively managed funds. This is because active fund managers have to beat their benchmarks, and also other active fund managers within the category.

Most fund managers within the industry all have access to similar information and insights. So the performance of most active fund managers in the industry would be similar to each other. This means that there is no inherent source of outperformance available to active fund managers. Fund managers who lack competence would naturally be decisively beaten by benchmark returns over a period of time. So the only source of outperformance available to a competent active manager today would be the underperformance of other active managers around them.

This effectively means that any outperformance achieved by active funds is attributable to luck rather than the actual skill of the manager. And therefore, when an active fund or manager achieves true outperformance, it does not sustain for long.

It is also important to remember that while the maximum downside for a stock is 100%, the upside is limitless. Moreover, only a select set of stocks within an index are likely to beat the index over a period of time. So long term stock returns may not resemble a bell shaped curve which is representative of a normal distribution. This invariably means that stock returns do not cluster around the average or median return. They usually tend to be skewed, most often towards the right.

This means that active fund managers would have to identify these stocks in advance during each period. They would also have to gain adequate exposure to them in their funds. This is the only way they would be able to outperform the index. But this is extremely hard to do correctly and consistently. And this points to the recurring conclusion that outperformance in active funds is extremely hard to achieve and sustain.

The higher costs associated with active funds are meant to compensate the fund manager for his skills. But as shown by any SPIVA report, active fund managers achieve outperformance more through luck than skill. And they cannot sustain it when they achieve it. So investors compensate their fund managers for something that very few do well (if at all). This just proves that parking money in active funds is a raw deal for investors. And that should be the most important takeaway for investors from the latest or any other SPIVA India report.

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