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Where Active Managers Beat Their Indexes

Unlike their global peers, Indian fund managers have high success rates. We explore how they do it.

Morningstar, 12/19/2016

By Shwetabh Sameer

Across the world, the dominant narrative is that it’s hard for active managers to outperform their indexes; it’s hard for investors to identify winning managers in advance; and even harder for investors to stick with them through inevitable cycles of underperformance. Therefore, the story goes, investors should control what they can and opt for low-cost passive funds that promise to match market performance (minus expenses).

This narrative runs aground in India.

It is long known, at least anecdotally, that Indian actively managed funds have outperformed their benchmarks despite their high expense ratios. (The average expense ratio for an Indian largecap active fund is around 2.5%.) In this article, we attempt to answer three questions:

1 Do India’s active funds truly outperform?
2 If they do outperform, is the outperformance explained by systematic factors?
3 Does the outperformance persist?

Two caveats are in order. First, we only considered active funds domiciled in India in the study; we don’t include India-focused funds that are domiciled outside India. Second, we limited the analysis to Morningstar India’s large-cap and small/mid-cap categories and excluded the tax savings and flexicap categories. The large and small/mid-cap categories account for the largest proportion of funds by number and assets under management, and they have the long track records necessary to draw meaningful conclusions.

To answer the first question, we used the same methodology as the one used in the Morningstar Active/Passive Barometer study, with some necessary adjustments. Morningstar’s Active/ Passive Barometer is a semiannual report that measures the performance of U.S. active managers against their passive peers within their respective Morningstar categories. While the U.S. study measures active managers’ success relative to the actual, net-of-fee performance of passive funds, we used the performance of appropriate Morningstar India Indexes1net of expenses across different categories, owing to the dearth of passive funds in Indian fund categories.

E X H I B I T 1 shows the survivorship and success rates of Indian active open-end equity funds for different holding periods by their beginning-of-period category as classified by Morningstar. Survivorship rate indicates the percentage of active funds that started the period and survived till the end, while the success rate indicates the percentage of active funds that survived as well as generated a return greater than their passive benchmarks.

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