Dissecting the Performance of Mutual Funds: Past and Present

Mutual funds are characterized as an important avenue for investment especially for retail investors who want to partake in the stock market but have little knowledge about the same. In the Nepalese context, after the introduction of the Mutual Fund Regulation in 2067, numerous mutual fund schemes have been introduced. Mutual fund as an alternative for investment has now existed for more than a decade. With some mutual funds already matured and others currently in active status, this study aims toward dissecting the performance of matured mutual funds as well as existing mutual funds and provide evidence on whether the mutual funds can be considered an efficient vehicle of investment for potential investors. Fig 1. Shows the compounded annual return of various matured mutual funds and the respective return of NEPSE and fixed deposits in the same period. Of the total 7 mutual funds, all have comprehensively beaten the annual return on fixed deposits which is considered a prominent alternative of investment in the Nepalese context. Furthermore, 6 out of 7 mutual funds that have matured were also able to beat NEPSE in a very convincing manner which further cements the position of mutual funds as a commendable investment alternative. 

While investing in stock market, timing matters a lot and this is fairly evident from the fact that SIGS1 and NBF1 were able to generate very high compounded annual returns compared to the other 5 mutual funds. These two aforementioned mutual fund schemes were introduced right at the beginning of the bull rally in circa 2013 which allowed them to enjoy full momentum. Furthermore, the fund size of SIGS1 and NBF1 were NPR 500 million and 750 million respectively, which can be considered a sizable amount in that period of time given that the daily average turnover was around NPR 890 million at the peak of the bull market of 2016. The remaining 5 funds although had a lower CAGR, were still able to beat NEPSE (barring NIBSF1). Furthermore, SEBON’s policy to allocate 5% of total IPO to mutual funds meant that during the initial years, SIGS1 and NBF1 were able to enjoy abnormal returns from these IPO allocations with additional returns contributed by the growing market. With very few mutual funds operating in the market, the IPO benefits were substantial. To put things into perspective, on an average, 24 IPO issues amounting NPR 15 billion were issued on an annual basis up until the bear market of 2019.

The attractive returns provided by the matured mutual funds have created a great platform for the new mutual funds to attract investors while issuing their schemes. In hindsight, investing in mutual fund would be the right decision rather than investing in random companies in the market without proper analysis. Whilst the past mutual funds’ performance portrays a rosy picture, this study also focuses on the returns of prevailing mutual funds to see if such superior performance has continued to persist in the current market scenario.

In Fig.2, the returns of current mutual funds show a different picture compared to the returns of the past matured funds. The average return of these funds is around 11.83% which seems to be quite lower compared to the previous matured funds shown in Fig.1. It is to be noted in Fig2. the mutual funds are presented in chronological order from left to right.  One of the major reasons for such subdued performance seems to be the timing of issuing such funds. The majority of these funds seem to have entered the market while the bear market had only begun. Increasing average fixed deposit rates in Fig2. (from left to right), also suggests that the funds operated mostly during the bear market. However, these funds have nevertheless managed to generate returns almost on par with that of the fixed deposit. Some of these funds, namely, NMBHF1, NEF, NIBLPF, and LEMF which are on the verge of maturing in approximately 1 year’s time, have struggled to generate returns superior to that of fixed deposits. Similarly, the remaining funds have either superseded NEPSE returns or are close to attaining NEPSE returns with SFMF and NMB50 being the funds that have returns above 15%.

Since the mutual funds presented in Fig.2 were all introduced in different time periods, it is quite difficult to compare their performance. For this purpose, the performance of all existing mutual funds is evaluated based on their performance in the recent bull rally i.e., between the period of Mangsir 2076 and Shrawan 2078.

Fig.3 shows that out of all the existing mutual funds, only two funds namely NEF and NIBLPF were close to beating the NEPSE Index. Not a single mutual fund has been able to generate returns superior to NEPSE.  Apart from the aforementioned two mutual funds, the minimum and maximum deviation of the remaining mutual funds’ returns are 24.18% and 46.91% respectively from the NEPSE’s return. Given the fact that there are no derivatives instrument in the Nepalese stock market, the current form of the stock market can be considered a one-way market and in such a market, a bullish run offers a great opportunity for these funds to generate returns. However, being unable to make the most out of such a bullish run is a huge opportunity loss for the mutual funds.

Whilst the performance of the existing mutual funds in the bull rally seems to be quite underwhelming, this study further tries to evaluate the performance of the same fund manager in its past and present mutual funds having a similar schematic theme. Fig. 4 shows the performance of two fund manager and their respective matured and existing mutual funds in their respective bull rally. In the case of Siddhartha Capital, it is quite evident that their first mutual fund scheme i.e., SIGS-1 was able to outperform the market even in the bull rally. However, the performance of its existing mutual fund SIGS-2 in the current bull rally seems quite underwhelming. There seems to be an unfavorable deviation of 34.30% between the market return and that of SIGS-2. Similarly, NBF1 also seems to have performed almost on par with the market return with an acceptable deviation. However, the gap in the return has widened when it comes to the existing mutual fund NBF2, with an unfavorable deviation of around 33.33%.

The deviation in terms of existing mutual fund’s performance of the same fund manager compared to their matured funds provides interesting insights about the possible structural changes in the market. Firstly, as the number of mutual funds has increased, the IPO quota has also been divided amongst these larger number of mutual funds. As a result, the benefits that were once shared between a couple of mutual funds in the past have now been shared with many mutual funds. This has definitely diluted the returns of mutual funds as the number of units of each IPO allocated to a given mutual fund has dwindled.

Similarly, many studies have shown that the Nepalese stock market has gradually moved from a weak form efficiency towards a semi-strong form of efficiency. Therefore, the fund managers in the past might have been able to generate excess returns based on analysis of public information available in the market. However, as such public information is now available through various online portals and most of the investors have access to such information in real-time and are also able to execute buy/sell decisions in a real-time basis (using TMS), making abnormal profits becomes highly unlikely based on public information. This is quite in line with the proposition made by the Efficient Market Hypothesis with regard to semi-strong form markets. It seems that mutual funds need to focus on much more in-depth research and analysis works that go beyond public information in order to generate excess returns for their investors.

Furthermore, investigating the number of scrips in the existing mutual funds indicates that on average, the mutual funds have around 64 stocks in their portfolio. Referring to numerous studies conducted in the Indian market as well as other Asian markets, it has been suggested that the ideal number of stocks in a given portfolio to eradicate unsystematic risk is around 25-30 stocks. It is to be noted that in these markets there are more than 10 times the number of stocks listed in NEPSE. Therefore, the current number of stocks in the mutual funds does seem to be quite high, and therefore, mutual funds need to focus on downsizing the number of stocks and focus on specialization and much more active management strategies in order to attain close to or even exceed the market returns.

Resorting to passive strategies of matching the index and lack of consistency in performance over the entire period might result in subpar returns. A significantly higher number of existing funds struggling to even beat the average returns of Fixed Deposits might spell disaster for the new mutual funds that are on the verge of issuance. As the market is heading towards increasing participation of institutions through mutual funds, it is the moral responsibility of such fund managers to maintain superior performance to retain confidence and increase the reach to new retail investors.

-Lelish Maharjan & Raunak Karanjit. 

Lelish Maharjan works a Senior Investment Associate and Raunak Karanjit is employed as Head-Investment Manager at Garima Capital Limited.