MF time: Shooting stars on the horizon

The past year tested the mettle of equity fund managers. Index fund evangelists raised the pitch as the second year of underperformance gave them an opportunity to point fingers at ���active��� fund managers. To be fair, though, the underperformance is not as bad as it is made out to be.

It���s true that if you take Sensex returns in 2006 as the benchmark, none of the 23 equity-linked savings schemes (ELSS) funds outperformed. But if you take the realistic benchmark of S&P CNX 500 ��� since most equity schemes choose from these stocks rather than just large-cap stocks of the Sensex ��� the outperformance figure is higher at 44%. In other words, out of 23 funds, 10 funds managed to give returns that were more than that of CNX 500.

The underperformance levels have been among the lowest in the past five years. In 2005, 77% of the funds gave higher returns than the CNX 500; in 2004, this figure was 76%. The outperformance seen in 2006 is among the lowest levels of underperformance seen among equity fund managers. Meanwhile , 2003 and 2000 saw similar levels of outperformance at 48% and 41%, respectively . While 2003 marked the start of the bull run in the stock market, 2000 was the year of the technology crash.

Does the underperformance mean that investors should invest in equities only via index funds? This is definitely not the case, since over a longer time frame of five-seven years, equity funds have comfortably outperformed their benchmarks. For instance, over a fiveyear period, 82% of the funds managed to outperform CNX 500 returns.

If you stretch the performance to include the bear phases of 2000 as well, 69% of the funds outperformed CNX 500 returns over a seven-year period. This is a relatively good performance as it proves that for retail investors, sticking to active equity funds still make sense, though they need to keep an eye on the duds to make timely exits.

As per the current ET Mutual Fund Tracker ratings, in all, nine equity funds got the platinum edge. The two platinum ELSS ��� Sundaram Tax Saver and Principal Tax Savings ��� have low risk scores. Their risk-taking propensity, as measured by downside risk, is 40% lower than that for its category. But again, all these funds, had lower risk scores.

While index fund managers may crib about underperformance , mutual fund investors are still better off, at least in terms of returns ��� after all, how many asset classes have given average returns of 33% in the past year? But as a fund strategy, investors should closely track fund performance quarter-on-quarter and if there are signs of continuous slippages in its performance , they should change the fund.