Mumbai: The country’s benchmark stock index, the Sensex, has more than doubled in the past six months, but that hasn’t brought much cheer to a large proportion of mutual fund investors. Nearly three-quarters of the Rs82,751 crore assets managed in large-cap diversified equity schemes underperformed the Sensex because of conservative calls by fund managers, who started buying only late in the rally.

Outperforming: The Bombay Stock Exchange building in Mumbai. Abhijit Bhatlekar/Mint

Between 9 March and 19 September, the Sensex rose 105.15% as foreign institutions bought Indian stocks on prospects of faster economic growth. But according to data from mutual fund tracker Morningstar, only 20 of the 107 large-cap equity diversified schemes beat those returns. The majority, representing 78% of mutual fund assets under management, failed to better the Sensex. Measured against the 93.38% rise in the 50-stock Nifty, 56% of assets under management fell short.

Passively managed funds or index funds, which mirror a benchmark, have done better. Ten out of 19 had a tracking error of 2% or more, meaning they have returned 2 percentage points less than the underlying index.

These funds don’t usually outperform the underlying index as they have expenses charged to their net asset values. Out of seven index funds that track the Sensex, three had returns in excess of 104% against the benchmark’s return of 105.6% between 9 March and 24 September.

A passive investment strategy “always works, not just now", said Sanjiv Shah, executive director at Benchmark Asset Management Co. Pvt. Ltd, a fund house that manages only index and exchange-traded funds. “Even if you take a three-year track record, you will find that these funds have done better than actively managed funds."

Out of the 12 index funds that track the Nifty, three did marginally better than the index, with the ICICI Prudential Index Fund topping the table with returns of 94.62% against the Nifty’s 93.79% gain. The worst-performing index fund in this period returned 87%.

With the worst-performing active funds showing returns of 52-53%, investors say they were sitting on cash positions as high as 30% of total assets.

“It’s not just the high cash level. It’s a multiplicity of factors, including cash, defensive stock positions, sectoral choices and calls between large-cap and small-cap stocks that has led to the underperformance of funds," said Krishna Sanghvi, vice-president (equities) at Kotak Mahindra Asset Management Co. Ltd.

Cash levels in equity funds peaked around February and March, when month-end data showed an average 18% and 15%, respectively. Some funds even had cash of over 50%. Mutual funds report cash levels only at the end of each month. The average cash levels came down to around 10% in June, July and August.

The relatively poor performance was also because funds were concerned the elastic would break, having held off buying before the general election, splurging after the results came out in May and then getting cold feet once again.

Between 9 March and 1 June, domestic institutional investors (including banks and insurance companies) bought just Rs1,332 crore of Indian stocks, net of sales, according to the Securities and Exchange Board of India, the market regulator. During this period, the Sensex rallied from 8,160.40 to 14,840.63, surging 82%.

Funds worried at the time about the April-May general election were either holding cash positions or taking bets on futures and options, say experts. Due to the uncertainty, “people were not putting money" into the market, said Hemant Rustagi, chief executive of Wiseinvest Advisors Pvt. Ltd, a financial advisory firm. “Suddenly, after the results, the Sensex went up by 2,000 points in a day. And there was a feeling of having missed out. Once that happens, people become aggressive."

After the Congress-led United Progressive Alliance won a decisively, local funds went on a buying spree expecting the new government would speed up reforms and growth would get a boost. Between 1 June and 24 September, they made net purchases in excess of Rs14,000 crore. They then hit the brakes when the prospects of further liberalization looked less likely and an erratic monsoon dampened spirits.

“From an investment perspective, most of us got it wrong because we were avoiding companies with weak balance sheets, weak cash flows and fundamentals," said Saurabh Mukherjea, head of equities at financial services firm Noble Group Ltd. “But unfortunately, many of these have been the best performers in this rally. Even among the Sensex companies, the best companies have not been the best performers."

Fund managers say its important to be defensive in a volatile market situation.

“With liquidity returning, there is a rapid repricing and revaluation of assets. All junk companies are going up dramatically. This has led to the underperformance," said Gopal Agarwal, head of equities at Mirae Asset Global Investments (India) Pvt. Ltd.

R.K. Gupta, managing director of Taurus Asset Management Co. Ltd, which managed Rs798 crore as of 31 August, said, “In a narrow period of two-three months between March and May, the Sensex has moved from 8,000 to 14,000. Funds were not ready to commit as the situation was so fluid, with uncertainties surrounding the global economy and elections. June onwards, when things stabilized, the market started moving in a narrow range of 15,000-15,500 before the recent spurt. This is the reason most funds have underperformed."