How asset classes performed over 5 year on risk adjusted returns?

28 Sep 2023 , 12:41 PM

We do look at the performance of mutual funds over a shorter period of say a year or a couple of years. However, there are two important things we need to remember about mutual fund return rankings. Firstly, for a ranking of mutual funds to be credible, it has to be for a longer period. Ideally, risk assets should be assessed over a longer period of 7-8 years, but in this case we can use 5 years as a good proxy. Also, these returns must be CAGR returns to give the right cumulative picture. The second important aspect is that risk has to be factored in. If you compare two fund managers with different levels of risk appetite, it would be like comparing apples and oranges. The outperforming fund manager could actually be doing the same by taking on more risk. You can adjust for that factor by focusing on risk adjusted returns, rather than pure returns.

Mutual Funds as a proxy for asset classes

In this case, we have mutual funds as a proxy for asset classes. Broadly, we have classified assets into 3 classes viz. equity, debt, and other assets. The other assets category includes specific classes like gold funds, silver funds, liquid funds, and hybrid asset classes. In our normal discussion on asset classes, the focus is largely on equity and debt only. However, if you look at the last 20 years, there have been years when liquid assets or gold have outperformed all asset classes. That is why we are also including other assets as a category. For each of these asset classes, the risk (volatility) is calculated using range, instead of standard deviation. Range may not be the perfect measure of risk, but it offers a good approximation over time. Then these returns for each asset class is ranked based on the risk-adjusted average class returns. The focus is not on the quantum of risk adjusted returns, but on where they stand vis-à-vis other assets in the similar category.

How debt funds performed over a 5 year period

In this segment, we look at the complete gamut of debt funds. For simplicity, we have removed very short term funds like liquid funds and arbitrage funds from this list as they are not comparable with regular debt products. Very short end products, not only operate on a different risk/return scale, but they also cater to a different audience and to a different purpose. That is why these shorter end funds have been clubbed under the category of alternate assets or other asset classes. The table below ranks the debt oriented funds (income funds) based on risk adjusted returns. As is the normal practice, any outliers in the data set, is automatically eliminated to ensure it does not distort the rankings.

Morningstar  Category	Category Average	Top Performer	Bottom Performer	Returns Range	Risk-Adj Returns
Floating Rate	6.38	9.05	4.80	4.25	1.5012
Long Duration	6.99	10.10	4.76	5.34	1.3090
10 yr Government Bond	6.87	8.82	3.22	5.60	1.2268
Government Bond	6.89	8.98	3.34	5.64	1.2216
Medium to Long Duration	5.97	8.51	2.56	5.95	1.0034
Money Market	5.30	7.78	2.13	5.65	0.9381
Banking & PSU	6.30	10.35	3.60	6.75	0.9333
Short Duration	5.74	9.45	2.85	6.60	0.8697
Ultra Short Duration	4.88	7.30	0.48	6.82	0.7155
Low Duration	4.90	7.13	-1.25	8.38	0.5847
Corporate Bond	6.18	12.21	0.74	11.47	0.5388
Medium Duration	5.25	9.07	-1.18	10.25	0.5122
Dynamic Bond	6.22	14.50	0.00	14.50	0.4290
Credit Risk	4.54	8.40	-4.03	12.43	0.3652

Data Source: Morningstar

What are the key takeaways from this ranking of debt funds on a CAGR basis over the last five years?

• The five year period gives a good mix of debt market situations as it includes key events like the ILFS / DHFL bankruptcy, rate hikes, rate cuts post COVID, hawkishness to control inflation and a long period of high inflation in the economy.

   

• The top performer is (believe it or not) floater funds. The reasons are not far to seek. During this period, floating rate funds gained from rising rates. But, more importantly, the asset choices are limited so most of them have similar portfolios. Hence, the range of returns is quite low and that worked in their favour.

   

• The other top ranked funds over a 5 year period were long duration funds, 10-year government bond funds and G-Sec funds. Longer duration funds have gained by holding on to debt and by replacing debt. Most of these longer duration funds had higher average returns than floating rate funds, but lost out due to higher volatile. Most long duration funds tend to be more volatile by default.

   

• What about the laggards in the last 5 years. These are typically the fund categories where asset quality has been an issue. Not surprisingly, Credit risk funds are at the bottom of the heap. But, other categories like low duration funds, medium duration funds and corporate bond funds also took a hit due to asset quality risk.

Overall, debt funds in the last 5 years belonged to the longer duration funds. But, the clear winner was floater funds, amidst hawkish rates and lower risk of volatility.

How equity funds performed over a 5 year period

We now move to how the equity funds as an asset class performed over the last 5 years on CAGR basis and what were the gainers and losers. The table below captures the gist of our findings over the last five years.

Morningstar Category	Category Average	Top Performer	Bottom Performer	Returns Range	Risk-Adj Returns
Sector – Healthcare	17.11	20.22	13.00	7.22	2.3698
Dividend Yield	13.71	17.81	10.69	7.12	1.9256
Large & Mid- Cap	15.13	19.06	11.16	7.90	1.9152
Value	14.29	18.71	9.47	9.24	1.5465
Contra	14.42	22.09	12.50	9.59	1.5036
Multi-Cap	16.97	24.49	10.81	13.68	1.2405
Sector – Financial Services	12.79	17.70	7.29	10.41	1.2286
Small-Cap	21.42	30.58	13.11	17.47	1.2261
Mid-Cap	17.63	25.62	10.07	15.55	1.1338
Equity- Infrastructure	17.93	27.28	10.42	16.86	1.0635
Focused Fund	13.28	21.26	8.43	12.83	1.0351
Large-Cap	12.74	22.76	7.94	14.82	0.8596
Flexi Cap	13.75	23.93	5.58	18.35	0.7493
ELSS (Tax Savings)	14.11	26.61	7.18	19.43	0.7262

Data Source: Morningstar

Here are some key takeaways from this ranking of equity funds on a CAGR basis over last five years?

• The five year period gives a good mix of equity market situations. It included the 2018 tightening, the 2019 slowdown, the 2020 pandemic and the post pandemic recovery amidst rising inflation. That gives a good mix to assess winners and laggards.

   

• The top performer is the healthcare funds category, which is not surprising as they were the big beneficiaries of the COVID pandemic. This sector also managed to keep volatility at a low level. Among the other winners on the risk adjusted list were dividend yield plays and the large & mid-cap plays. While dividend yield plays gave exposure to high performing PSU stocks, the large & mid-cap plays were the low risk mid of large and mid-cap stocks, which has done well in the longer term.

   

• Mid cap and small cap funds, which are the most sought after by retail investors today, are more in the middle of the ranking. That can be attributed to the higher risk that these funds bring to the table, with corrections being much sharper than the large caps. That has dented its long term risk-adjusted returns.

   

• What about the laggards in the last 5 years. ELSS, flexi caps and Large caps are in the bottom of the heap. ELSS, is a classic case where the lock-in is not ensuring higher returns or lower risk. Recent tax changes have not helped either. Flexi caps do not have a five year history, but in the last couple of years, the experience has been that the flexibility in flexi-caps may not be adding value compared to multi-caps. On the large cap front, it is more about kurtosis resulting in underperformance.

Overall, the equity funds in the last 5 years belonged to the smart alpha hunters. Investors are gravitating away from large caps towards passive index funds and index ETFs.

How alternative assets performed over a 5 year period

As stated earlier, this covers all the asset classes other than long term equity and long term debt. We have clubbed hybrid assets as well as asset classes like liquid funds, arbitrage fund and precious metals in this list.

Morningstar Category	Category Average	Top Performer	Bottom Performer	Returns Range	Risk-Adj Returns
Sector – Precious Metals	12.77	13.37	12.14	1.23	10.3821
Balanced Allocation	9.29	11.99	6.70	5.29	1.7561
Arbitrage Fund	4.71	5.93	2.72	3.21	1.4673
Dynamic Asset Allocation	9.93	16.27	6.35	9.92	1.0010
Aggressive Allocation	12.39	21.17	6.05	15.12	0.8194
Equity Savings	8.05	11.91	1.65	10.26	0.7846
Conservative Allocation	7.21	11.93	2.37	9.56	0.7542
Liquid	4.19	5.90	-2.74	8.64	0.4850

Data Source: Morningstar

There are some interesting takeaways that emerge from the risk-adjusted ranking of the alternate asset classes over a 5 year period. You would be surprised to know that over the last 5 years, gold is not just the best performer among this particular segment, but it is also the top performer among all asset classes including equity and debt. That is largely on account of robust returns over the last five years and very low levels of volatility risk. Now, that is a very tough combination to compete with. Investors who ignore including gold in their gold in their portfolios as a hedge, must keep this in mind.