How fund categories performed on risk adjusted returns post-COVID

7 Jul 2023 , 11:26 AM

Of course, the idea of returns can be refined. You can use CAGR returns over a longer period of time so that the effect of compounding is also captured. Also, you can benchmark against TRI returns rather than pure returns to get a better picture of outperformance of the fund. But that is at a very specific fund level. Here we tweak the idea to a more category level.

We all know that the markets touched a low during the pandemic and also staged a phenomenal recover after that. However, pure returns do not factor in risk and hence it tends to be an inaccurate measure of performance. Sample this case. If two funds generate 13% CAGR returns over a 3 year period, we would assume that such funds are comparable. But one fund may have taken inordinately high risk to earn this 13% compared to the other fund. That difference also needs to be highlighted.

Enter risk-adjusted returns

One way to overcome this problem with pure returns is to look at risk adjusted returns. In mutual fund parlance, there are two popular measures of risk-adjusted returns viz. Sharpe Ratio and the Treynor Ratio. Both these ratios divide the excess returns by risk. The only difference is that the Sharpe Ratio uses standard deviation as the measure of risk while the Treynor Ratio uses Beta as a measure of risk. 

What we do here is slightly different. Instead of going into the specific funds, we will look at the fund categories across equity, debt, and alternatives. We will divide the average category returns by the risk to get risk adjusted returns. The only difference is that, instead of using standard deviation we use range as the measure of risk here. We consider the range between the highest category returns and the lowest category returns. Then under each class of funds, the various categories will be ranked on risk adjusted returns.

How equity funds ranked on 3-year risk-adjusted returns

The table captures the top performing fund categories under the header of equity funds on risk-adjusted returns as explained above. As a matter of practice, outliers will be removed to get a much better median view.

Morningstar Category	Category Average	Top Performer	Bottom Performer	Range Variation	Risk Adj Returns
Equity – ESG	22.84	22.99	15.48	7.51	3.041
Large & Mid- Cap	26.31	31.91	20.39	11.52	2.284
Dividend Yield	24.88	34.10	22.40	11.70	2.126
Sector – Financial Services	27.71	33.47	18.13	15.34	1.806
Multi-Cap	28.48	38.67	19.39	19.28	1.477
Sector – Technology	26.92	36.66	18.29	18.37	1.465
Sector – Healthcare	17.83	24.12	11.63	12.49	1.428
Mid-Cap	30.95	40.30	18.58	21.72	1.425
Contra	25.47	41.38	22.76	18.62	1.368
Focused Fund	23.31	32.51	15.16	17.35	1.344
Value	27.03	41.00	20.58	20.42	1.324
Large-Cap	22.43	33.48	16.49	16.99	1.320
Equity- Infrastructure	33.27	51.00	24.32	26.68	1.247
Small-Cap	40.12	59.36	26.11	33.25	1.207
Flexi Cap	23.42	39.61	8.31	31.30	0.748
ELSS (Tax Savings)	24.55	45.93	12.77	33.16	0.740

Data Source: Morningstar

We have removed FMCG funds as only fund is considered and it becomes  biased. Interestingly, in the post COVID period, it is the ESG funds that have done the best in terms of risk-adjusted returns. This can be attributed to the spike in interest in these environmental, social and governance issues post the pandemic. Interestingly, the large & mid-cap funds have done very well on risk-adjusted terms post COVID as the combination of large caps and mid-caps has helped performance. Also,  most companies have increased their dividend payouts and that has helped the dividend yield funds.

On the downside, ELSS continues to remain at the bottom of the equity heap, where the 3 year lock-in does not seem to be helping. Also, the discretionary flexi-cap funds and the small cap funds are not doing too well in risk-adjusted terms. Interestingly, even large caps rank low on the risk-adjusted returns scale, which possibly explains the shift to passive index funds by many investors post the pandemic. 

How debt funds ranked on 3-year risk-adjusted returns

The table captures the top performing fund categories under the header of debt funds on risk-adjusted returns as explained. As a matter of practice, outliers have been removed to get a much better median view.

Morningstar Category	Category Average	Top Performer	Bottom Performer	Range Variation	Risk Adj Returns
Money Market	4.43	5.34	2.29	3.05	1.452
10 yr Government Bond	3.13	4.28	1.64	2.64	1.186
Long Duration	2.75	4.00	1.04	2.96	0.929
Government Bond	3.91	5.61	0.50	5.11	0.765
Floating Rate	5.14	8.90	2.14	6.76	0.760
Low Duration	5.02	8.13	1.09	7.04	0.713
Corporate Bond	4.29	6.19	-0.40	6.59	0.651
Ultra Short Duration	4.48	7.42	0.04	7.38	0.607
Medium to Long Duration	4.19	8.92	0.27	8.65	0.484
Short Duration	5.09	11.98	1.38	10.60	0.480
Banking & PSU	4.46	6.66	-3.85	10.51	0.424
Medium Duration	5.61	14.27	0.00	14.27	0.393
Dynamic Bond	4.51	19.04	-0.48	19.52	0.231
Credit Risk	9.39	43.13	1.33	41.80	0.225

Data Source: Morningstar

The interesting finding from the debt category data is that the best performing fund category in the post COVID period is the money market fund as they have been less vulnerable to interest rate movements. There has been a preference for the longer tenure funds like, where most of the returns occurred during falling interest rates in 2020. There has been a lot of investors locking into such funds at higher yields. Even floating rate funds did fairly well and that can be attributed to a fairly long period of rising bond yields between March 2022 to February 2023. All these categories have not only earned higher returns but also managed to keep risk in check.

Among the bottom performers are two categories of funds. There are the credit risk fund and the banking / PSU funds where there was an element of credit risk. These funds have been among the worst performers in the aftermath of the pandemic and also the Templeton fiasco. Apart from the credit risk funds, other discretionary debt funds like dynamic bond funds and medium duration funds have also performed low on the risk adjusted returns scale.

How alternate funds ranked on 3-year risk-adjusted returns

Apart from pure equity and pure debt funds, we have clubbed all the other categories into the alternative segment. This includes hybrid funds, liquid funds, and commodity funds. 

Morningstar Category	Category Average	Top Performer	Bottom Performer	Range Variation	Risk Adj Returns
Sector – Precious Metals	5.76	6.17	4.66	1.51	3.815
Balanced Allocation	15.92	19.76	11.56	8.20	1.941
Arbitrage Fund	4.24	5.36	1.51	3.85	1.101
Equity Savings	11.67	15.98	4.78	11.20	1.042
Aggressive Allocation	20.31	34.00	12.73	21.27	0.955
Liquid	3.93	5.97	0.00	5.97	0.658
Dynamic Asset Allocation	13.83	27.45	6.20	21.25	0.651
Conservative Allocation	9.71	16.67	0.01	16.66	0.583

Data Source: Morningstar

The top performing category are the precious metals funds in terms of risk-adjusted returns and that is largely due to the low volatility in returns. Interestingly, the balanced allocation funds (BAFs) have been the top performers, and here interestingly discretion appears to have worked. However, conservative allocation funds with a predominance of debt have not done too well, since the post pandemic period has been all about equities.

Key takeaways from the post COVID performance

Here are some key takeaways from a quick analysis of the post-COVID performance of various fund categories.

• In the equity category, the ESG funds have done very well while a mix of large and mid-caps have helped. However, pure small cap or flexi cap funds have not done too well.

   

• Among debt funds, the post COVID period has been marked by oscillation of rates. So, you have money market funds, long duration funds and floaters among top performers. However, debt funds with discretion have not done too well
   

In the alternate world, gold still appears to rule the roost, and that is more due to the low volatility in returns. The post pandemic world has been about equities, so an equity oriented allocation strategy has helped.