Today, the AMFI publishes Information Ratio along with the returns data of a fund on its website. Information Ratio or IR, captures whether the fund beat the index returns, and how much of these returns were generated by fund manager performance. In a bull market, the pure momentum makes ordinary managers look like stars. Also, there are managers who earn higher returns on the fund by taking on higher risk. That may be smart in the short term, but risky in long term. The information ratio is a single number that actually distils wheat from the chaff. 

If we look at large cap equity funds over last 10 years, the top 10 funds gave 13-14% returns CAGR on an average. That is impressive over the longer term. But the picture changes when we look at the Information Ratio (IR). Out of the top-10 funds by CAGR returns, only 2 funds have managed to generate positive IR. The other 8 funds have not even given the returns they should be generating in the market. However, if we look at the IR of direct plans, then 8 of these 10 funds have positive IR. Focus more on cutting your cost, than on chasing the winners.  

How does the story change if we look at the mid-caps and rank the top-10 based on CAGR returns over 10 years? Average returns would be in the range of 16-17% over 10 years, which is good. However, the picture is not so flattering when we look at the Information Ratio (IR). Only 1 out of the top-10 mid-cap funds have managed to deliver positive IR, which is even worse than the performance of the large cap funds. If you shift from regular plans to direct plans, then 5 out of the top-10 are giving positive IR. The irony is that mid-caps are supposed to do better than large caps. While returns are better over the longer term on average, the IR leaves a lot to be desired for mid-caps. 

Interestingly, the small cap funds are the real outperformers on Information Ratio over a 10-year period, despite their risk quotient. Small Cap funds have averaged returns of 17-18% CAGR over 10 years. However, if you look at the IR over this period, then 7 out of the top-10 funds have generated positive IR; which means they have earned more than what they were expected to earn. Interestingly, if you make a shift  from regular plans to direct plans,  then all top-10 small cap funds have a positive IR. This probably explains why there has been a shift from large cap funds to index funds. After all, even in the very long run, cost makes a big difference to fund performance!