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Mystery shrouds mutual funds that have lost edge

Let me quote from a dialogue in a recent Dilbert comic strip that spoofs corporate life. Dogbert the CEO is holding forth on business plans.

india Updated: Aug 31, 2009 21:53 IST

Let me quote from a dialogue in a recent Dilbert comic strip that spoofs corporate life. Dogbert the CEO is holding forth on business plans.

“We’re getting into the financial services game. That way, all our products can be imaginary,” he says, and then, while talking to the pointy-haired boss, elaborates, “We’ll start ten mutual funds, each with randomly-chosen stocks.

Later, we’ll build our advertisements around whichever one does the best purely by chance. My goal is to be the premier provider of imaginary expertise.” I don’t know how many mutual fund investment managers would have given a guilty start upon reading this strip, but I’m willing to guess that at least a few would have.

Does this really happen? Do mutual fund companies actually launch a lot of funds with more-or-less randomly chosen variations and ride the roll of the dice? Some fund or the other will always do well and you’ll basically get by. As it happens, Value Research is in the middle of a large project to analyse a fundamental shift in the relative performance of Indian equity funds evident over the past three years.

I have been tracking Indian mutual funds for almost two decades now, and it has always been clear to me that Made-in-USA theories about most funds not being able to outperform the market indices were simply not true for India. For most of this period, a large proportion of equity funds had consistently beaten the Nifty and the Sensex by a wide margin. There were long periods (long as in five years and above) when above 90 per cent of funds would beat the big indices consistently. During the entire period, you would never find a single article or paper by an indexing proponent which would dare to quote Indian data.

But please note that I’m talking in the past tense. Things have changed. There are still plenty of Indian funds that beat the indices and by good margins. But their numbers are fewer and the list is not consistent. While this was expected, what is puzzling is that it seems to have happened in a narrow time-band that can be pointed to the mid-2006 correction.

After this, the consistency with which funds beat indices declined sharply and has never really picked up. Of course, most of the period after mid-2006 has not been very normal anyway, but I don’t think that’s an explanation. Whatever has happened is of considerable importance to the investor and I hope we will figure out the mystery soon.