Alpha in Indian Large Cap Equity Funds - A Tale of Two Periods

We look at the trend of alpha generation among 18 large-cap equity mutual funds in India between September 2010 and August 2021. Between September 2013 and December 2017, these schemes, on average, outperformed a NIFTY 50 index tracker fund (average annualised 3-year alpha of 3.22%), but since January 2018 have, on average, underperformed the index tracker (average annualised 3-year alpha of -1.65%). While average R2, a traditional measure of active management or selectivity, between returns of large-cap schemes in our sample and those of a large-cap index tracking fund, has remained stable at 0.93 through the period, there have been key changes to selectivity of schemes. 1 in 3 funds every month have had R2 >= 0.95, a popular benchmark for “closet index” funds. We show that the pandemic has significantly impaired the returns from selectivity as seen in the jump in the average R2 from 2020 and is a significant driver for the drop in 3-year alpha between 2018-2021. Finally, there is a weak but significant inverse relationship between large-cap scheme alpha and R2.