MF strategy: Is there a good time to buy or sell actively managed funds?

Trying to find the best time to buy or sell a fund doesn't help because most of the time, even outperforming funds track or trail the index, according to a study conducted by Morningstar. 

Over the long haul, the stock market's outperformance over cash boils down to just a few critical months. Critical months are those months whose removal from the return series would eliminate the fund's

outperformance over its benchmark. Miss those months and you will have missed all the risk premium to be earned from holding a volatile asset such as equities.

To see what actively managed funds look like from the critical months' perspective, Morningstar conducted a study that used active funds' returns over the 10 years from October 2013 through September 2023. Categories considered were ELSS, large cap, flexi cap, large and mid-cap, mid-cap and small-cap.

Over this period, Indian stocks owed their outperformance over cash to just 12 months—10% of the months in the sample. If you held stocks for all 108 months apart from those 12 months, which we will call "critical months," you would not have beaten cash. On average, less than 4.2% of the months account for all of the outperformance for Indian actively managed diversified equity funds versus their benchmark, revealed the study.

On average, less than 4.2% of the months account for all of the outperformance for Indian actively managed diversified equity funds versus their benchmark.

Morningstar's previous version of the study, published in April 2022, showed that over a 10-year period (April 2012 to March 2022), Indian stocks owed all their outperformance over cash to just 11 months, or 9.2% of all months. Similar numbers were witnessed for actively managed funds, where, on average, just six months, or 5% of all months, accounted for their outperformance versus their benchmarks.

This is not just an Indian phenomenon. In a global study released by Morningstar in 2019, similar trends were found for U.S. large-cap stocks for investments since 1926, where 5% of the months attributed to the overall outperformance over cash. Similarly, the global study of outperformance for the last 15 years found that 5% of months account for the outperformance of actively managed funds globally.

The obvious implication of these findings is that it is exceedingly hazardous to try to time markets. Staying invested is the name of the game, be it in equities as asset classes or the funds through which you select to invest.

“Active management turns out to follow the same dynamic as the market as a whole. It is thus natural that the implications for buying and selling actively managed funds should be similar to those regarding timing entire markets,” said Melvyn Santarita Analyst, Manager Research at Morningstar.

What is the implication for an investor? 

"The implication is that investors should not try to time investments in actively managed funds. Staying invested is the name of the game. Actively managed funds are finding it harder to beat benchmarks. In addition, the number of months contributing to overall outperformance versus benchmarks of these funds is shrinking," said Kaustubh Belapurkar, CFA Director, Manager Research at Morningstar.

Morningstar believes investors are best served by identifying consistently managed funds and by staying invested. "Investing based on recent performance can be counterproductive, resulting in missing critical months of performance in both the newly invested fund(s) as well as the exited fund(s)," said Santarita.

“If you think you have identified a skilled manager, the best course of action is to buy in or rupee-cost average, regardless of the moment, and hold on to the fund over long periods. The obvious, and perhaps even the most important corollary, is that a fair amount of patience is required to adhere to such a program,” said the researchers.

“A good manager may take a long time before critical months materialize. Thus, don’t sell based on the ‘what have you done for me lately’ rationale. The gospel of wisdom can be adapted to active management: No one knows the day or the hour when outperformance will strike," they added.