Alpha in active funds matter of 6 months; futile to time the market: Morningstar

Timing the market to earn a robust return is every investor's goal. However, data shows that any outperformance in the stock market is a matter of few months - be it in individual stocks or mutual funds.

"On an average, Indian actively managed diversified equity funds' outperformance was attributable to a smaller proportion of months: 6 months or 5 per cent of all months in the 10-year period from March 2011 to February 2021," says a report from Morningstar.  This is lower than the number from 2019 study of 8 months or 6.7 per cent of all months.

For the overall markets, Indian stocks owed all their outperformance over cash to just 8 months, or 6.7 per cent of all months during the same period. "If you held stocks for all 112 months apart from those 8 months, which we will call "critical months," you would not have beaten cash," says the report.

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What does it mean?

'Time in the market', as is said often, matters more than 'timing the market'. If you stay invested in the market for the long haul, there are high chances that your investment will gain the benefit of critical months when the outperformance happens. If you miss those months, you will miss the risk premium equities enjoy over other asset classes.

"The obvious implication of these findings is that it is exceedingly hazardous to try to time markets. Staying invested is the name of the game, be it in equities as an asset classes or the funds you select to invest through," says the report.

The report said there is a solid evidence that most actively managed funds' excess returns are not normally distributed.

"But from our perspective, the exact shape of that distribution does not matter. What matters - and this is the most practical implication of our findings - is that trying to find the best time to buy or sell a fund is most likely futile. Most of the time, even outperforming funds basically track or trail the index. If you think you have identified a skilled manager, the best course of action is to buy in or rupee cost average, regardless of the moment, and hold on to the fund over long periods of time," says the report.

"A good manager may take a long time before critical months materialize. Thus, don't sell based on the "what have you done for me lately" rationale. The gospel of wisdom can be adapted to active management: No one knows the day or the hour when outperformance will strike," it adds.

This is not just an Indian phenomenon. A global study released by Morningstar in 2019 revealed that similar trends existed for US large cap stocks for investments since 1926, where 5 per cent of the months were attributed for the overall outperformance over cash. Similarly, the global study of outperformance for the last 15 years found that 5 per cent of months account for the outperformance of actively managed funds globally.

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