We have constantly voiced the need to have a long-term perspective when investing in equity, as an asset class. To borrow from the old age, what really matters is time in the market rather than timing the market.
The reason being that over the long haul, the stock market's outperformance over cash boils down to just a few critical months. Miss those months and you will have missed all the risk premium to be earned from holding a volatile asset such as equities.
To see what actively managed funds look like from the critical months' perspective, we conducted a study that used active funds' returns over the 10-year period from October 2013 through September 2023.
Over this period, Indian stocks owed their outperformance over cash to just 12 months—10% of the months in the sample. If you held stocks for all 108 months apart from those 12 months, which we will call "critical months," you would not have beaten cash. On average, less than 4.2% of the months account for all of the outperformance for Indian actively managed diversified equity funds versus their benchmark.
(Our previous version of the study showed us that over another 10-year period (April 2012 to March 2022), Indian stocks owed all their outperformance over cash to just 11 months, or 9.2% of all months. Similar numbers were witnessed for actively managed funds, where, on average, just six months, or 5% of all months, accounted for their outperformance versus their benchmarks.)
Here is an excerpt from the report.
Exhibit 1 displays aggregate statistics for critical months, first in aggregate and then grouped by fund category. One can immediately see that whether it's mean, median, or the top- and bottom-quartile breakdowns, these numbers are small and should give little comfort to investors who try to find the best times to buy and sell actively managed funds. In aggregate, the median number of critical months was four. That means that half of the funds' outperformance was due to four or fewer months. One in four funds (25th percentile) owed their outperformance to only two months! Finally, three fourths (75th percentile) of all the funds' outperformance was attributable to seven or fewer months. Small-cap funds and large- and mid-cap funds were the best of the pack, while, expectedly, funds with a large-cap bias had the worst results.
Finally, we divided funds by deciles of outperformance. Exhibit 2 shows how many critical months, on average, each decile had. Even the best decile of outperforming funds, on average, owed their outperformance to just 14 months of excess returns. That is one year and two months out of 10 years.
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