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Asset Allocation

Mutual Funds or ETF

The topic is something I have written about earlier but given the nature of the market, it keeps propping up as one or the other side unearths what seems to be new evidence which show why one is better than the other. In the United States, its more or less settled that Active funds cannot beat simple ETF’s and this is not just limited to Mutual funds as the bet by Warren Buffett is showcasing.

Ravi Dasika, Co-Founder, Tavaga.com wrote a post on Medium trying to show why the viewpoint of Sharad Singh, Founder and CEO of Invezta.com wherein it was claimed that 95% of all funds beat ETF’s was simply and absolutely wrong. Before we go any further, a word on these two sites. Tavaga.com is a site founded to provide investors a way to build portfolio’s using simple ETF’s while Invezta.com is a site that provides investors with the ability to invest in Mutual Funds Direct (other sites such as FundsIndia for example are sites that provide avenue to invest via Regular schemes which are more expensive ,0.5% to 1.25% approx depending on fund.)

In other words, they offer their customers a choice that is pretty much opposite (Passive vs Active) and even while the total pie of investments that is coming into the equity markets is pretty high, like in the United States, at some point we shall see some sort of cannibalization.

Given the background, lets explore what Sharad Singh wrote at Business Today in his post More than 90% active mutual funds beat the indices. There is still time for ETFs. I would suggest you read the article though the conclusion (as would be evident from the headline itself) was that ETF’s were inferior to active Mutual Funds.

To make a case for Active, Sharad combined ETF’s and Index funds on one side and all Mutual funds on the other. While Index funds are supposedly passive and theoretically should move like the Index, it rarely does so thanks to Tracking Errors that dominate. Either way, Sharad takes a total of 17 ETF’s. I on the other hand could find a total of 24 funds (18 Index, 6 ETF’s) with a minimum track record of 5 years.

Here is the list with returns

As the data evidently shows, ETF’s handsomely beat Index Funds some of which can be attributed to fees (IDBI Nifty Index fund for example charges 1.74% as its Expense) while others maybe due to the churn needed to continually adjust for the inflows / outflows. While even ETF’s face that issue, due to the size of the Creation Unit being large, I believe that impact is much lower in their case.

Now, lets look at Mutual Funds (and since Direct funds are still a very small portion of Retail Investors, I shall use Regular)

On an average, Mutual funds have indeed outperformed both Index Funds and ETF’s by a margin. But what data misses is the fact that this data is skewed in two ways.

One, the starting point of the 5 year analysis starts right after the bear market of 2011. A fund which had a higher beta than the Index would surely outperform given the overall bullishness in the period.

Second, the 10 year returns are of funds that continue to exist. Any fund that was closed / merged would be missed propping up the returns higher (since its generally weak under-performing funds that find themselves under the axe).

Even more important point to note is that if you had invested in any of the funds on the left hand side, you would have either kept in line with the ETF or under performed. On the other hand, investing in funds on the right hand side should have given you a return much higher than what you could have got through ETF’s / Index funds. But either way, its not a 95:5 split but more of a 50:50 (Coin Toss). (Errata: Only 22% of funds have under-performed not 50%. Apologies).

Do note that while we compare all the funds against Nifty 50, its actually a wrong way to compare since many of the above funds have pretty large investments in stocks outside the Nifty 50. On the other hand, if you were to invest equally into both Nifty 50 and Nifty Next 50, you would more or less get the entire population. But since we have just 2 ETF’s with minuscule AUM’s, it would not be a fair comparison.

Over the last 5 years, Nifty Next 50 has given a return of 20.24% showcasing where and how the extra returns by the funds above maybe been garnered. One can only hope that we see more launches to track indexes such as these making it easy for potential investors to invest in a ratio that has a very high probability of beating the best of the funds (which are recognized only in hindsight).

If you were looking at investing for the long term, a good mix of Nifty 50 and Nifty Next 50 on the equity side should beat the shit out the majority of funds 10 / 20 years from now, that is unless you know which fund to buy and forget for the next decade.

Finally, the goal of investing is to ensure that our Goals are met. The road you prefer is left to you and while most of us will still arrive at our destinations, the time taken maybe different due to the different roads we took to reach.



2 Responses to “Mutual Funds or ETF”

  1. What about the brokerage costs of ETF ? Are they included in this analysis ?

    Posted by Surya | 13th January 2017, 2:14 pm
  2. “Finally, the goal of investing is to ensure that our Goals are met”

    who said this..goal is to have 5* rating, beat the benchmark every year with maximum alpha, beta, sharpe ratio. i have 5 excel sheets to prove this

    Posted by ajayrajaram | 14th January 2017, 11:23 am

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