Precious metals still rule the roost on 5-year risk-adjusted returns

WHY WE LOOK AT RISK-ADJUSTED RETURNS?

Unlike pure returns, risk adjusted returns, give a picture of the returns per unit of risk. It is very easy for a fund manager to show higher returns in the short term by taking on more risk. But that is normally to the detriment of investors. The answer lies in looking at returns adjusted for risk. Here we have done that by dividing the 5-year CAGR returns by the range, which is a crude measure of risk, but effective, nevertheless. Here is the updated story.

##GENERIC EQUITY FUNDS: RANKED ON 5-YEAR RISK-ADJUSTED RETURNS

Here is the ranking of 7 categories of generic equity funds based on market cap.

Data Source: Morningstar

Over a 5-year period, all generic categories have given CAGR returns of over 12.5%, which is impressive. Interestingly, it is mid-caps that score on risk-adjusted returns. While their returns are top-of-the-line, even the risk in mid-caps is lower than small caps and at par with large caps. At the bottom of the list are the flexi-cap funds, where the flexibility has resulted in a bigger range of returns. That has worked against flexi-caps in the long run.

THEMATIC EQUITY FUNDS – RANKING ON 5-YEAR CAGR RETURNS

Here is how the 11 categories of thematic equity funds rank on risk-adjusted returns.

Data Source: Morningstar

The defensive sectors like FMCG, consumption, and healthcare are right at the top in terms of risk-adjusted returns. That story has worked over the longer run. Aggressive themes and aggressive sectoral bets have not done too great; as in the case of technology and financial services. Even some of the specific themes like dividend yield and value have not done too well in the risk-adjusted rankings.

HYBRID ALLOCATION FUNDS – RANKING ON 5-YEAR RISK-ADJUSTED RETURNS

Here are 5 categories of hybrid allocation funds and their rank on risk-adjusted returns.

Data Source: Morningstar

In the hybrid space, the bias is in favor of funds that offer a mix of debt and equity. Interestingly, Balanced Allocation Funds are at the top, followed by conservative allocation. This indicates that asset allocation still works in longer range returns. Aggression and flexibility have ranked much lower. The focus clearly should be on rule-based asset allocation, rather than too much discretion to the fund manager. That is what works in the long run.

ACTIVE DEBT FUNDS – RANKINGS ON 5-YEAR RISK-ADJUSTED RETURNS

Here are the 14 categories of debt funds and their rank on risk-adjusted returns.

Data Source: Morningstar

While flows into debt funds may be focused at the short end of the duration curve, the returns are dominated by funds at the long end of the duration curve. This could be skewed by the fact that after peaking in 2022, rates have been steadily moving downward, which has favored the longer duration fund categories. Despite being longer duration, credit risk funds are at the bottom, but that is more due to portfolio quality issues as is evident from the range risk.

ALTERNATE FUNDS: RANKING ON 5-YEAR RISK ADJUSTED RETURNS

Here are the 3 categories of alternate fund classes on risk-adjusted returns.

Data Source: Morningstar

The above table underlines two recent day realities. It shows why gold and silver ETFs have been in such heavy demand. Precious metals have not just outperformed in the short term, but in the longer term too. More importantly, this has been achieved with very low risk implication. Secondly, the table also shows why there is a gradual shift in short term preference from liquid funds to arbitrage funds. It is about risk-adjusted returns, apart from the tax efficiency!