Even in long run SIPing in only right fund can generate alpha

Systematic Investment Plans (SIPs) have become synonymous with wealth creation in the modern financial landscape. Their disciplined approach, coupled with the power of compounding, allows even small investors to accumulate significant wealth over the long term. Albert Einstein famously called compounding the “eighth wonder of the world.” In essence, it means your returns generate further returns, creating an exponential growth snowball.

So can we assume that doing SIP in any fund will lead to wealth generation!! The data analysis suggests otherwise and brings to fore the importance of Right Selection. It is seen that over extended periods, even a small underperformance or outperformance in your chosen mutual fund(MF) scheme can significantly impact the final corpus.

However, while SIPs offer a robust framework for growing wealth, their success hinges on one crucial element – Selecting the right mutual fund Schemes.

At Upwisery Data Insights, A back testing carried out on actual past performance of SIP has some interesting insights. Here Upwisery created two separate portfolios i.e. Portfolio A and Porfolio B, with 4 MF schemes. Each of these funds were selected based on the below framework:

1. MF Schemes which have a track record of more than 20 Years
2. MF Schemes with sufficient liquidity with cufoff of AUM of more than 1000 Cr
3. MF Schemes which are sector agnostic (No Sectoral/Thematic Funds were included)

Using the above filter, 20 MF’s were shortlisted, out of which the 4 Schemes in the top quartile became the part of Portfolio A and the 4 schemes in the bottom quartile became the part of Portfolio B. The performance of both of these portfolios,on a monthly SIP of Rs 10,000 each per scheme was than analysed, at the end of 10, 15, 20 years.

While both portfolios delivered positive return, a closer observation led to interesting insights. At the end of 20 years, while Portfolio A delivered an average annual return of 16.70%, Portfolio B delivered a 13.24% return. An alpha of 3.46%, does it really matter that much? The answer is an emphatic YES and by a great margin. After 20 years, Portfolio A grew to approximately Rs. 6.56 crore, compared to Portfolio B’s Rs. 4.28 crore. This translates to a staggering Rs. 2.28 crore difference due to the 3.46% underperformance of Portfolio B.

Portfolio Comparison – SIP Amount 40,000 (In Cr)

Having an underperforming portfolio, can lead to a big dent in the final corpus as the tenure of investment increases and thus creating shortfall in achievement of final goals. The difference can be even stark based on how the portfolio has been built – composition of top quartile small and mid cap schemes have the capability to give an alpha of over 4-7% compared to the average to bottom quartile schemes. The below table gives an perspective of how the final corpus changes with every 0.5% difference between performing and underperforming portfolio.

We can see that the difference increases drastically as the investment tenure increase from 10 to 20 years. A small change of 0.5% or 1% can create a huge difference at the end of 20 years.

Sensitivity Analysis (Amount In Cr)

So the key to generate wealth and meet investment objectives is to put effort and build the portfolio through selecting the right mutual fund schemes.

But easier said then done, as on December 31, 2023, there are 1,363 open-ended schemes, out of which we have 424 schemes under the Equity Category only. Even if we exclude ELSS & Sectoral/Thematic Fund categories, we are still left with 233 Schemes. (Source: AMFI)

The vast universe of available funds offers a plethora of choices, each with its own set of characteristics and potential returns. Navigating the vast universe of available options and selecting 8-10 schemes can be a complex and challenging task for an investor.

It is equally important to note that the past performance is not a guarantee of future results. Accurately evaluating a fund’s potential based on historical data and market trends requires expertise and financial literacy. Analyzing a fund manager’s track record, investment philosophy, and risk management skills can be challenging, especially for new investors.

Also the emotional biases, such as fear, greed, and overconfidence, can influence investment decisions. Investors may be swayed by short-term market trends or succumb to herd mentality, leading to suboptimal fund selections.

While self-directed investing is becoming increasingly accessible, a financial advisor can be a valuable partner in navigating the complex world of equity investments. Their expertise, guidance, and bespoke approach suited to each investor can significantly increase your chances of making informed investment decisions and achieving your financial aspirations.