Why most funds & portfolios underperformed the benchmarks in 2022?

Fund Managers as a whole, more or less, mirror the market, says Mr. Samir Arora of Helios Capital. 

Since they themselves are the market, by definition all of them cannot outperform the market. If there were no cost or fee, approximately half would outperform and half would underperform the market each year. 

The fact that in real life there are fees and expenses means that there is one more hurdle to cross to achieve outperformance, says Mr. Samir Arora. 

This is why only 40% or less of active fund managers beat the market every year. There is also a significant churn of outperforming fund managers each year and therefore in the longer term (5 years or more)) less than 25% of the active fund managers beat the market (as the same fund manager has to repeatedly do well to perform well in the medium to long term). 

Even though in general less than half of the active fund managers beat the market each year, the statistics for 2022 are much worse. There are many reasons for this, but the most significant reason, according to Samir Arora, is related to the type of stocks that have done well this year. Most active fund managers and investors have stayed away from commodity stocks and oil and gas stocks for various reasons from government ownership to ESG concerns etc. Due to high inflation and the Russia Ukraine war, energy prices shot up and this year’s biggest outperformers are stocks like Coal India (up 73%) and NTPC (up 43%). Additionally, most fund managers missed the sharp rally in Adani group stocks which helped the index but were missing from portfolios of most Indian funds. 

One more factor that has hurt many portfolios is the regime shift from “growth stocks” to “value stocks” as high inflation and high interest rates made growth stocks with high valuations and “future” cash flows less attractive while India fund managers have traditionally favored growth stocks. 

Although it is good to have a fund manager who beats the market every year, this is a very unrealistic expectation. In recent years, many new fund managers have raised money on the basis of seductive investment philosophy with zero real life track record. Investors investing on the basis of hindsight analysis and performance of paper portfolios are likely to be disappointed as real life decision making is different from analysis of the past. What is important for investors to see is the longer term track record of the fund manager over a number of cycles as that is the best indicator of the value added (or not) by the fund manager.