Is investing in mutual fund right for you?
Updated: Sep 19, 2019
Over the last few years, mutual funds advertisement come out as if these are backed by government approval. Let's look at the data to understand whether mutual funds have added any value to its investors.
By what margin a mutual fund beats the market is called 'alpha'. For example, a fund delivered 30% and Nifty delivered 28%, alpha is 30%-28% = 2%. Alpha represents the value add done by a portfolio manager. In case a portfolio manager doesn't add a lot of alpha, what's the point of giving him your money. You are better off buying low-cost Nifty Exchange-traded Fund and staying invested.
Now let's pick one top-performing and one bottom performing fund in each of the equity categories. This way we can understand in simple terms whether mutual funds added value in these categories or not.
We observe that large-cap funds have not been able to generate positive alpha. Rather than investing in actively managed funds, an investor would have been better off with a large-cap index fund.
Across all categories investment in the so-called bottom performer would have been disastrous even for 5 years. Picking a good fund manager is the key to mutual fund performance.
There is a case to invest in quality mid-cap and small-cap funds. However, investing in the bottom performer can even erode the principal amount.
If we expand this time horizon to 10 or 15-year period, there is a massive alpha. This is used as a case for investing in mutual funds. However, over the last few years, alpha is eroding especially in the large-cap space.
Mid-cap and small-cap mutual fund investment requires due diligence on the fund manager. This will ensure that you are invested in the top quartile funds. With alpha being eroded in the large-cap, a tailored strategy or an index fund can be evaluated.