Tag - mutual funds

The Myth of Consistent Outperformance

In the active fund management industry, there is no better sign of investment insight than to overcome the odds and produce excess returns with unfailing regularity. This notion is bogus because patterns of consistent outperformance are exactly what one would expect to see if results were entirely random. This measure alone tells us nothing and believing in it would lead investors to an array of investing mistakes.

The careers of most star fund managers have been shaped by seemingly rare runs of good form. Performance consistency is also often used as a tool for rating and filtering active fund managers – with skill linked to how regularly they beat their benchmarks over each year/quarter/month. To think that the delivery of regular benchmark beating returns is indicative of skill, investors need to believe one of two things:

  • For a fund manager or team to outperform consistently, investors must suppose that they can accurately predict future market conditions. Without having this ability, it is impossible to position a portfolio to outperform in a constantly evolving environment.
  • Financial markets will consistently reward a certain investment style. If investors do not accept the first notion, then they must believe that a fund manager has a flawless approach that always outperforms- regardless of the market conditions.

Stories over randomness

The existence of consistent outperformers is almost certainly the result of fortune rather than skill.  In any activity where there is a significant amount of randomness and luck in the results, outcomes alone tell one next to nothing about the presence of skill. The only way of attempting to pinpoint skill is by drawing a link between process and outcomes. In order to claim performance consistency is evidence of skill, one should justify the part of the process that leads to such unwavering returns.

Consistently poor behavior

The obsession with performance consistency is not just a harmless distraction, but an issue that leads to poor outcomes for investors. There are three main problems:

  • It leaves investors holding unrealistic expectations about what active funds can achieve. A rule of thumb to follow- if a fund has outperformed the market for five years straight, then at some point it will underperform for five years straight.
  • Buying funds that have shown unusually strong run of performance leads to entering markets at expensive valuations. Markets tend to converge to their mean values over time and by walking into expensive valuations investors may have to sit through painful mean reversion.
  • Narratives surrounding consistent outperformance promote the glorification of star fund managers.

Source: The Myth of Consistent Outperformance by Joe Wiggins on www.behaviouralinvestment.com

Asset Multiplier Comments

  • Fund investors should focus on the consistency of the philosophy and process of a fund manager. In an unpredictable environment, one’s investment approach is the only thing that can be controlled.
  • Believing that consistent outperformance is the evidence of skill can lead to capital erosion.
  • Instead of chasing active mutual funds, investors can go passive. Sticking to this approach in a disciplined way will ensure slightly better performance than active funds over the long run as fees are comparatively lower.

Disclaimer: “The views expressed are for information purposes only. The information provided herein should not be considered as investment advice or research recommendation. The users should rely on their own research and analysis and should consult their own investment advisors to determine the merit, risks, and suitability of the information provided.”

This week in a nutshell (April 26th to April 30th)

Technical talks

NIFTY opened the week on 26th April at 14,449 and closed on 30th April at 14,631. It made a weekly gain of 1%. The index is trading above its 20DMA of 14,618 which might act as a support. On the upside 50DMA of 14,783 might act as a resistance. The RSI (50), and MACD turning downwards suggests a further possible decline.

Weekly highlights

  • The Reserve Bank of India (RBI) capped the tenure of MDs and CEOs of private banks at 15years. Promoters can hold this post for a maximum of 12 years but the RBI can choose to give them a 3-year extension under extraordinary circumstances. These rules apply to private banks, small finance banks, and wholly-owned subsidiaries of foreign banks. These new rules will apply once the tenure of existing MDs/CEOs for which approvals have been taken is completed. This will impact banks such as Kotak Mahindra Bank, where Mr. Uday Kotak has been the head of the institution for 17 years and there could be a change in the management once his term is completed in 2024.
  • The Securities and Exchange Board of India (SEBI) has directed the mutual fund (MF) industry that a fifth of the salary of top executives is to be paid in the form of mutual fund schemes they oversee. The allotment of MF units will be done every month and will be subject to a 3-year lock-in. The industry welcomed the move as it increases accountability and would ensure a better selection of securities.
  • Several automobile manufacturing companies have announced plans to shut down plants for up to a fortnight from May 1. The surge in Covid-19 cases and scattered lockdowns across states and cities are the reasons attributed to the temporary shutdown. This will impact production and sales in the June-21 quarter.
  • FII (Foreign Institutional Investors) selling and DII (Domestic Institutional Investors) buying trend continued this week as well. There was a net outflow of Rs 44571mn from the FII kitty while DII invested Rs 52833 mn.

Things to watch out for next week

  • The Automobile companies will report monthly volume data for April-21. The data will be important to ascertain the impact of the second Covid-19 wave and lockdowns on the demand.
  • The 4QFY21 result season continues in the next week as well. The Commentary from biggies such as Hero MotoCorp and HDFC will be critical.