How Indian Large Cap Funds Performed by Information Ratio

How have Indian large cap funds performed by Information Ratio

UNDERSTANDING THE RELEVANCE OF INFORMATION RATIO

Contrary to what many people believe, Information Ratio is not just the extent you beat the benchmark index. Information Ratio (IR) is about how much additional risk you have taken to generate that excess return. It is about whether the additional returns have come from skill of the fund manager or from taking higher risk than warranted.

A positive IR shows that the fund manager has beaten the benchmark index. But the gradation of the IR tells you whether it has come from skill or excess risk. Normally, an IR of over 1 is excellent while an IR of over 0.40 is good. In the table below, we have captured IR for large cap funds; separately for Regular Plans and Direct Plans.

BROAD CONTOURS OF LARGE CAP FUNDS IN INDIA

In India there are a total of 35 large cap funds, with a combined AUM of ₹4,22,086 crore as of 06-November. Out of these 35 large cap funds, we have only considered 28 funds, where 5-years of data is available to calculate the 5-Year IR.

The 28 funds with 5-year track record have given average 3-year CAGR returns of 12.20% and average 5-year CAGR returns of 9.58% in their direct plans. We have considered direct plans to avoid the skew of TER costs.

The 28 large cap funds with 5-year track record have been ranked on the Information Ratio (IR) of regular plans and of direct plans to understand how the marketing and distribution costs impact the returns of the funds.

WHAT WE READ FROM THE RANKING OF LARGE CAP FUNDS?

Here are key takeaways from the updated large cap fund performance.

There has been a turnaround in the performance of large cap funds as the Nifty 100 stocks have been the big beneficiaries of the recent rebound in the markets and the surge in FPI buying. FPIs were net buyers of $5.70 billion in 6 days of November.

If you look at the Information Ratio of Regular Plans for the 5-year period, then out of the 28 funds considered; only 10 have a positive IR and 18 have negative IR. Also, if you average the IR of all these 28 Regular Plans, it stands in negative at -0.17.

The picture changes when you look at the Information Ratio of Direct Plans for the 5-year period. Out of the 28 funds; 18 have a positive IR and only 10 have negative IR. Also, if you average the IR of all these 28 Direct Plans, it stands positive at 0.21.

What does this dichotomy between the IR rankings of Direct and Regular Plans show? Clearly, the marketing and distribution costs are making a big difference to fund manager performance. It also explains the shift to passive index funds and ETFs.

Did investors actually make money in the positive IR funds? If you look at the total AUM of the 10 large cap funds (Regular) with positive IR, it comes to ₹1,94,618 crore. That is approximately 46% of the overall AUM of large cap funds.

What is the total AUM of positive IR large cap funds under Direct Plans. These 18 Direct Plans with positive IR had a combined AUM of 2,97,279 crore. That is nearly 70.4% of the overall large cap AUM. In short, bulk of the investors are benefiting.

One good inference that emerges is that the returns over 3 years and 5 years have been quite consistent for the top performing funds. That means; funds have been consistent in their performance. In such cases, past performance on IR can be a good gauge of the future and investors can use that as a guiding tool to invest.

By opting for direct plans in large cap funds, investors have the chance to score high on Information Ratio (IR) as well as combine the benefits of alpha and low costs.