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Published: October 15, 2022 at 6:00 am
As of Aug 31st 2022, 59.5% of the total equity AUM was in Nifty 50 stocks. Here are the details and possible implications. The total equity AUM held by 40 mutual fund AMCs is Rs. 21,91,563.5357 Crores. The break-up is given below. The tables in this article are sourced from ACE MF.
Next, we look at the market value of the Nifty 50 stocks held by these AMCs.
The total AUM from these 50 stocks is Rs. 13,04,009.41 Crores. Therefore these stocks represent 59.5% of the total equity AUM (13,04,009.41/21,91,563.5357). The AUM from the top 10 stocks of Nifty 50 is Rs. 6,97,044.9372. So their contribution is 31.8%.
Most of this AUM is held by active mutual funds. The total passive AUM (excluding factor-based funds, mid cap and small cap funds) is approximately Rs. 3,31,157.3656 Crores.
Even if we assume the entire passive comprises only Nifty 50 stocks (this is incorrect, but do play along), 44.4% of the total Active equity, AUM was in Nifty 50 stocks and 16.7% of Nifty 50 top 10 stocks.
There are two reasons why active mutual funds hold such high quantities of NIfty 50 stocks. (1) They are large cap oriented, which is part of their investment universe and (2) they use them for liquidity. Even small cap mutual funds hold sizeable large cap stocks to hand in and outflows. There is, of course, nothing wrong with this.
According to SEBI registered fee-only advisory Avinash Luthria, “From the point of view of an individual active MF manager in an established MF house, it is rational to be a closet indexer or index hugger, i.e. ‘claiming to manage the fund actively when in reality the fund is very similar to the index”.
“This minimizes the risk of the fund massively underperforming the index for a long stretch of time and the individual active MF manager getting fired by their employer. This may be true whether or not the individual active MF manager has the skill to beat the index. This is true if one adopts my world-view that zero active MF managers in India have the skill to beat the index (due to randomness, a minority of active MF managers would have beaten the index in the past, and a minority of active MF managers will beat the index in the future)”.
“But this may also be true in the opposite world-view. Even if, by some miracle, one active MF manager in India has the skill to beat the index, he may still underperform the index for many years and get fired from his job before he can beat the index”.
“For a simple example, let’s look at it from the point of view of a Largecap active MF manager. For a Largecap active MF manager, the Nifty 50 index is in the ballpark of 87% of their benchmark. So from the point of view of an active MF manager who is a closet indexer, it is rational to have around 87% of their portfolio in Nifty 50 stocks”.
“Yes, the fund will underperform the index to some extent, but the fund manager can make up creative stories that the underperformance is due to some temporary factors (e.g. the underperformance is caused by the increase in AUM of passive index funds) and hence clients should wait for a longer period of time before they judge the fund. Until then, the active MF manager continues to earn a high salary”.
“The exception could be the CIO of an MF house with a tiny AUM. Here, some CIOs may decide that it is better to have a portfolio that is very different from the index. If they are lucky, they will get a large AUM and fees. If they are unlucky, then they may have to shut down the fund house. But anyway, as a MF house with a tiny AUM, the business was not viable, and they were anyway going to shut down the business. So they have nothing much to lose and something to gain from deviating from the index. So it may be rational for some CIOs of MF houses with tiny AUMs to have a portfolio that is very different from the index. But the action of a tiny MF house will not make much difference to the aggregate data of the active MF industry as a whole.”
There is a possible downside to active mutual funds holding such high quantities of NIfty 50 stocks. An index is just a basket of stocks. If more people invest in these stocks preferentially, the index will increase. It is not a secret that institutional investors prefer large cap stocks.
They prefer the relative stability of large cap stocks and this, in turn, stabilises the index. This applies to foreign and domestic institutional investors (MF AMCs are one such entity). Also, see: 10 stocks hold nearly 46% of FPI money in India. The ten stocks are HDFC Bank, HDFC, Reliance Industries, ICICI Bank, Infosys, TCS, Kotak Mahindra Bank, Axis Bank, Bharti Airtel, and HUL.
This could possibly be one reason for the explicit difficulty observed over the last few years in the underperformance of active mutual funds (Avinash is not enthusiastic about this view, though!). This is, however, not a recent phenomenon. See: Poor performance of active mutual funds: Is this a recent development?
Look at the weights of the 10 ten Nifty 50 stocks. Just ten stocks constitute 58% of the Nifty!
Active mutual fund and portfolio managers lend momentum to the Nifty 50 each time they buy these stocks, regardless of their motivations. This could possibly make it harder for them to beat the index since not enough (stable) money is chasing the rest of the market (say, beyond the top 100 stocks). Matters become worse if the interest in mid cap and small cap stocks becomes lower than usual. This is a mixed blessing, and there is not much we can do about it except shift to index funds!
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