Last week, someone drew my attention to a write-up that had appeared on a website that is frequented by distributors. I was told that that piece “forcefully and decisively” made the case for debt funds over fixed deposits. It had been written by someone who has had significant experience in the business. It had been sponsored by a top fund house and had been applauded by a former CEO of another fund house. Hence, I approached it with a fair degree of enthusiasm. When I read it, my impressions were somewhat different.
While it was certainly forceful, I felt that it was presumptuous, and was built around questionable assumptions. Its centrepiece was a table with an ambiguous caption that stated that it was based on data of “some popular accrual schemes”. In that table, there was no mention of which schemes were considered or how many. All that the author gave was a summary of the returns from those schemes and flaunted those against the return from a SBI term deposit. Leave aside the fact that he ignored the quarterly compounding on the deposit. Consider this: unmistakably, one of those schemes was a fund which, over the period in question, had, on an average, just 6% of its portfolio in AAA rated investments. Yet he thought it fit to compare its return with that from a AAA rated bank deposit.
As I reflected on the incongruity of that, one thought led to another, at the end of which I felt like indulging in a similar comparison but with a very different objective. More specifically, I felt tempted to examine as to how often have bond funds across the industry given a better return than that from a SBI deposit. Most bond funds have the mandate to go beyond AAA rated securities. In addition, most also have some flexibility (in some cases, a lot) with respect to their average maturity. So it would be reasonable to expect most bond funds to beat the return from a SBI deposit, most of the time. Yet something told me that that might not actually be the case. In a small way, I had done something similar in the past, and that enabled me to quickly set the parameters of my examination as below:
1. To compare the returns from funds currently categorized by Value Research as ‘Short Term’ and ‘Ultra Short Term’ with the return from a 1-year SBI deposit for a retail investor. For the sake of simplicity, I decided to consider only calendar year returns from 2005 onwards (i.e. the earliest calendar year for which data is easily available on Value Research). I also decided to consider only Regular Plans and to ignore loads, if any.
2. To compare the returns from funds currently categorized by Value Research as ‘Income’, ‘Credit Opportunities’ and ‘Dynamic Bond’ with the return from a 3-years SBI deposit for a retail investor. For the sake of simplicity, I decided to consider rolling 3-years returns based on calendar years from 2005 onwards. Here too, I decided to consider only Regular Plans and to ignore loads, if any.
Here, then, are my observations:
| Total No. of Funds | No. of Funds Beating Bank Deposit | % of Funds Beating Bank Deposit | |
|---|---|---|---|
| 2005 | 39 | 8 | 21% |
| 2006 | 44 | 38 | 86% |
| 2007 | 48 | 31 | 65% |
| 2008 | 64 | 54 | 84% |
| 2009 | 72 | 5 | 7% |
| 2010 | 80 | 5 | 6% |
| 2011 | 90 | 81 | 90% |
| 2012 | 91 | 64 | 70% |
| 2013 | 97 | 53 | 55% |
| 2014 | 101 | 59 | 58% |
| 2015 | 103 | 24 | 23% |
| 2016 | 104 | 96 | 92% |
Fund Data Sources: Value Research, Morningstar
Additional Observations:
- Of the 39 funds that have been in existence since 2005, not a single fund gave a better return than a SBI deposit across all 12 calendar years. 12 funds gave a better return than the bank deposit in 8 years or more with 2 of these doing so in 10 of the 12 years. On the flip side, 11 funds underperformed the bank deposit in 7 years or more. One fund underperformed the bank deposit in 10 of the 12 years.
- Of the 97 funds that have been in existence over the last 4 calendar years, only 15 funds gave a better return than a SBI deposit in all 4 years. 51 funds outperformed the deposit in 2 out of these 4 years while 13 did so in only 1 year. 2 funds underperformed the deposit in each of the last 4 calendar years.
| Total No. of Funds | No. of Funds Beating Bank Deposit | % of Funds Beating Bank Deposit | |
|---|---|---|---|
| 2005 - 2007 | 37 | 21 | 57% |
| 2006 - 2008 | 38 | 27 | 71% |
| 2007 - 2009 | 40 | 16 | 40% |
| 2008 - 2010 | 45 | 5 | 11% |
| 2009 - 2011 | 49 | 0 | 0% |
| 2010 - 2012 | 55 | 46 | 84% |
| 2011 - 2013 | 62 | 21 | 34% |
| 2012 - 2014 | 66 | 27 | 41% |
| 2013 - 2015 | 73 | 32 | 44% |
| 2014 - 2016 | 77 | 66 | 86% |
Fund Data Sources: Value Research, Morningstar
Additional Observations:
- Of the 37 funds that have been in existence since 2005, not a single fund gave a better return than a SBI deposit across all 10 3-year periods examined. 5 funds outperformed the SBI deposit in 7 (or more) of the 10 periods. On the flip side, as many as 15 funds underperformed the SBI deposit in 7 (or more) of the 10 periods. One fund underperformed the SBI deposit in each of the 10 periods.
I don’t know about you, but looking at these numbers has given me a lot to think about.
For one, it makes me think why is it that despite the flexibility in deciding the credit quality and average maturity of the portfolio, so many funds, so often underperformed a AAA rated deposit. For another, it makes me wonder what might these tables look like if the returns were to be adjusted for credit risk and interest risk. It also makes me curious about how the underperforming funds might be justifying their expense ratios. In fact, I surmise that, in some instances, the existence of the funds themselves may be hard to justify.
I have long believed that, by and large, investors do not keep enough checks on the portfolios and performance of bond funds. In equity funds, the benchmark indices are well-tracked by most investors. Most sophisticated investors go a step further and examine the sectors and the stocks held. They also use risk-adjusted measures such as Sharpe Ratio and Sortino Ratio to get a better sense of performance. In bond funds, by contrast, most investors have no idea about their benchmarks, let alone their suitability, and their performance. Beyond the credit ratings, most investors are clueless about what fund managers hold. And it doesn’t help that there are no widely accepted measures of risk-adjusted return that meaningfully capture credit risk and interest rate risk.
Put differently, I believe that bond fund managers have had it relatively easy. Their performance is rarely scrutinized with the rigour and intensity that that of equity fund managers is. And (thus far) they don’t face any discernible threat of investors opting for index funds. They have also been fortunate that bank deposits do not offer income by way of capital gains (with its attendant tax benefits).
I think that these numbers should give bond fund managers, too, a lot to think about. As for investors, maybe its time to clamour for passively managed bond funds.
