Fund Fulcrum (contd.)
(October 2007)

Piquant parade (contd.)

US-based financial major, Goldman Sachs, is to establish an asset management company in India, with an initial investment of $ 50 million. Of the proposed $50 million, $7.5 million will be invested upfront and the remaining $42.5 million will be invested in the next 2 years.

Union Bank is planning to enter the mutual fund industry accompanied by a foreign company as its partner by the end of this fiscal.

Regulatory Rigmarole

The Securities and Exchange Board of India is looking at reducing the fees of all mutual fund schemes — equity funds (open- and close-ended), debt funds, index funds and even funds of funds. The first step in this exercise was Sebi’s proposal in August to scrap the entry-load payment on open-ended schemes that are bought through online applications or directly through asset management company collection centres instead of distributors.

This proposal by SEBI has faced opposition from the Financial Planning Standards Board (FPSB) India, a Mumbai-based professional standards-setting body for financial planners. As a first option, the Board has recommended that the rebating system should be reinstated for mutual fund distributors, but the discount given to investors should be properly documented. Under the rebating system, which was eliminated by Sebi in June 2002, distributors can give a certain percentage of discount to customers out of their commission income. The second option is a 'variable entry load' model at investor level under which a client and distributor can negotiate entry load on a transaction-to-transaction basis, based on the perceived value of advice. As per the present guidelines, variable loads are allowed at a scheme level. The proposed model, which is similar to the structure prevalent in the stock-broking industry, allows distributors to add value to its services to clients, without impacting the NAV. Currently, an investor hands over an amount to a distributor who gives it to the fund house. The fund house deducts the entry load from the amount and gives it to the distributor, who unofficially parts with a small portion of this money to the investor, thereby, denying the investor the entire benefits of the investment. In the proposed variable fee-based structure, the client pays the distributor a certain fee for the advice, over and above the investment amount. A third option suggested is a two-track system for charging loads marked by two options. One, a zero-entry load option carrying a higher exit load or, two, an entry load with no exit load.This will enable fund houses to retain an investor for a longer period of time.

In a bid to bring transparency in the manner in which mutual Funds charge expenses to closed-ended schemes, Sebi is likely to prohibit close-ended Mutual Funds from charging up to 6% of the corpus as initial offer expenses, which is then amortised over a period of time. Amortisation allows AMCs to show a higher NAV in close-ended schemes. For example, if you buy 100 units of Rs 10 each of a new close-ended fund, the fund house charges 6% as initial expenses, which means that the NAV should be Rs 9.40, but it is still shown as Rs 10 initially. The Rs 6 charged to the scheme is amortised over a period. In April 2006, Sebi had recast regulations relating to initial issue expenses and banned only open-ended schemes from charging 6% initial issue expenses. The open-ended schemes had to meet sales, marketing and other expenses through entry load (not allowed in the case of close-ended schemes), which is usually about 2.25%, and not initial issue expenses. The difference in treatment of expenses between open and close-ended schemes has made the latter attractive for fund houses.

The RBI has hiked the overall limit for overseas investments by mutual funds from $4 billion to $5 billion. The cap on overseas investments by individual mutual fund houses has been raised to $300 million from the earlier limit of $200 million or 8-10 per cent of the total assets under management, whichever was lower. In addition, the existing facility of investing up to $1 billon in overseas Exchange Traded Funds, as may be permitted by SEBI by a limited number of qualified Indian mutual funds would continue. This is subject to a maximum of $ 50 million per mutual fund. The requirement of 10 years of experience of investing in foreign securities for being eligible to invest in overseas Exchange Traded Funds (ETFs) has been dispensed with. Moreover, Indian mutual funds are now allowed to invest in a new basket of instruments overseas that include ADRs/GDRs issued by foreign companies, initial and follow-on public offerings, foreign debt securities in the countries with fully convertible currencies, which have a rating not below investment grade, and also money market instruments that are rated not below investment grade. Mutual fund can also invest in government securities of countries, which are rated not below investment grade. Other instruments include derivatives traded on recognised stock exchanges overseas only for hedging and portfolio balancing with underlying securities, short-term deposits with banks overseas where the issuer is rated not below investment grade, units/securities issued by overseas mutual funds registered with overseas regulators and investing in approved securities of Real Estate Investment Trusts listed in recognised stock exchanges overseas or unlisted overseas securities which are less than 10 per cent of their net assets.

Since mid-September, the pace of FII money in the form of Promissory Notes (PNs) flowing into the Indian bourses has been unprecedented leading to a bubble-like growth in stock prices and a steroid effect on the Indian Rupee. With FIIs dealing with PNs having been asked to register themselves with SEBI, the veil of threat shrouding the identity of those investing in the Indian stock markets have been done away with. The markets have since stabilized and the positive outlook is inviting many foreign funds to seek greener pastures in India.

Fund Fulcrum

India may have recently entered the elite club of trillion dollar economies, and companies here may have metamorphosed from frogs in the well to global predators, but at $88-billion worth of assets under management as against $21.8 trillion worldwide, India's mutual fund industry ranks a measely 24th in the world. This is not to say that the funds industry in India, a miniscule contributor to the world total, is not growing in terms of size and potential. It sure is, a fact reflected in the latest AUM (assets under management) tally released by the Association of Mutual Funds in India.

The mutual fund industry closed September 2007 with Rs 4.77 lakh crore of AUM, an increase of 2.15% compared with August 2007. Assets under management by mutual funds have remained flat for September, despite the BSE Sensex rising by around 13% during the month. The September pattern is cyclical in nature as it is nearing the half-year corporate results season when banks redeem their funds. Moreover, companies have to go in for advance tax as the half-year ends. Reliance Mutual Fund continued its run as the largest fund house with Rs 70440.57 crore of AUM in September 2007 followed by ICICI Prudential Mutual Fund at Rs 50369.93 crore. Occupying the third and fourth slots, the AUM of UTI Mutual Fund and HDFC Mutual Fund were Rs 45002.62 crore and Rs 41333.4 crore, respectively.

Piquant parade

The trickle of private equity money into the country’s infrastructure sector is now turning into a deluge, with a slew of billion-dollar funds dedicated to core sector financing on the anvil. Australia’s Macquarie Bank Group and the International Finance Corporation are slated to jointly launch a $1-billion ‘Macquarie India Infrastructure Opportunities Fund’, while Power Finance Corporation’s $1-billion ‘India Power Fund’ and the UK-based 3i Plc’s $1-billion ‘3i India Infrastructure Fund’ are among the dedicated core sector funds on the horizon.

Mirae Asset Global Investments (India) is being set up as a 100% Foreign AMC of Mirae Asset, one of South Korea’s largest mutual fund managers, and would be investing $50 million in India over a three-year period to set up its Indian arm for asset management.

About five years after it ended operations in India, Pioneer Investments has tied up with Bank of Baroda for asset management. The group, which has presence in 25 countries, will take 51 per cent in Bank of Baroda’s existing asset management company. Pioneer’s domain knowledge and technical expertise makes an enriching combination with the widespread branch network of the bank. The bank would continue to sell products of other asset management companies through its branches.

Corporation Bank has announced a strategic partnership for distribution of Birla Sun Life’s Mutual Fund products and Bank of Baroda for Franklin Templeton and Sundaram BNP Paribas Mutual Fund products.

South Africa’s largest insurer Old Mutual, which manages £263 billion in assets worldwide, will soon enter into a tie-up with Kotak Mahindra Mutual Fund.

India's second largest private sector lender Housing Development Finance Corporation (HDFC) has acquired an additional 10 per cent stake in HDFC Asset Management Company from Standard Life Investments Ltd - the investment arm of the UK-based Standard Life Plc taking its holding to 60%.

Rana Talwar’s Sabre Capital, backed by private equity giant Temasek, is in talks with Cholamandalam DBS Finance to take over the latter’s mutual fund company — DBS Cholamandalam Asset Management. A few other strategic investors are also believed to be in the fray. The fund’s AUM had dropped from over Rs 5,000 crore in July 2007 to around Rs 3,829 crore in September. If Sabre and Temasek succeed in the acquisition, they will merge the AMC with Lotus.

Reliance Mutual Fund concluded a pact with the world`s third largest risk management service provider - MSCI Barra, to offer services across all its funds.This alliance will help Reliance Mutual Fund to access MSCI emerging markets module that includes MSCI India Index, the common benchmark used by non-Indian investors looking to allocate money to Indian equity investments.

SBI and UTI Mutual Fund have bagged the lion's share of the pension-fund kitty. They, alongwith LIC, have been named fund managers for the new pension system and the National Investment Fund. Of the Rs 1,000 crore under the National Investment Fund, UTI MF will manage 60%, SBI 30% and LIC 10%. On the other hand, of the Rs 2,000 crore under the new pension scheme, SBI will manage 55% , UTI MF 40% and LIC 5%.

Post-rebranding, Axis Bank (formerly UTI Bank) is now getting ready to enter the mutual fund and trusteeship business. The third-largest private bank had earlier looked at the option of taking over UTI asset management company.

UTI AMC expects an increased focus on retail investors to help it regain the top slot in the industry. The fund house, which plans an initial public offering by March next year, manages more than 8.5 million accounts worth about 450 billion rupees in assets.

To be continued…

NFO Nest

The first eight months of 2007 (January to August) saw a total of 54 NFOs, a majority of them open ended, garnering Rs 15,409 crore, whereas in the same period last year, the fund houses collected nearly Rs 27,000 crore. Infrastructure, mid-cap and offshore investments have been the main theme of funds launched this year. DSP Merrill Lynch and Reliance Mutual Fund launched the largest number of funds this year - seven each. They are conspicuous by their absence in the September and October 2007 NFO Nest.

The following funds find their place in the NFO nest in October, 2007.

Lotus India Infrastructure Fund # Opens: 25 Sept, 2007 - Closes: 24 Oct, 2007

A three-year close ended equity fund, it would automatically be converted into an open ended fund after the expiry of three years from the date of allotment. Between 65 to 100% of the portfolio allocation will be in equity and equity-linked instruments of companies engaged in infrastructure sector selected by adopting the bottom up approach. Debt securities and money market instrument will comprise of 0 to 35% of the portfolio.

HDFC Arbitrage Fund # Opens: 28 Sept, 2007 - Closes: 15 Oct, 2007

HDFC Arbitrage Fund is an open-ended equity fund with the investment objective of generating income by investing predominantly in arbitrage opportunities between cash and derivative market and arbitrage opportunities within the derivative segment and by deployment of surplus cash in debt securities and money market instruments. There are nearly a dozen arbitrage funds at present delivering a return of 8 to 10 percent per annum.

HSBC Flexi Debt Fund # Opens: 3 Oct , 2007 Closed :3 Oct , 2007

HSBC Flexi Debt Fund is an open-ended debt scheme. The scheme has regular and institutional plans. For regular plan minimum subscription amount is Rs.10000 and for institutional plan minimum subscription is Rs. 50 lakhs. The investment objective of the scheme is to deliver returns in the form of interest income and capital gains, along with high liquidity, commensurate with the current view on the markets and the interest rate cycle, through active investment in debt and money market instruments.

UTI Energy Fund

To enable the investors to capture the growth potential of a broad based energy sector, UTI Mutual Fund is widening the investment objective of its existing UTI-GSF-Petro and renaming the Fund to UTI Energy Fund. The new offer is an open ended equity scheme. The investment objective of UTI-GSF-Petro was to invest in petro sector companies which constitute only a part of the overall energy sector. The investment objective of UTI Energy Fund will cover the entire energy sector to capitalize on the emerging opportunities across the sector. In addition to investing in stocks in the oil & gas sector covering companies engaged in drilling, exploration, refining of crude oil and distribution, UTI Energy Fund will also invest in power generation companies (power generation, transmission, distribution and power trading & companies involved in consulting and financing these businesses), energy storage and distribution companies and equipment manufacturers for the energy sector.

Sahara R.E.A.L. Fund # Opens: 5 Oct , 2007 Closes: 2 Nov , 2007

Sahara R.E.A.L. Fund is a close-ended equity fund with an automatic conversion into an open-ended fund upon expiry of 36 months from the date of allotment. The investment objective is to provide long term capital gains by investing predominantly (at least 90%) in equity/equity related instrument of companies in Retailing, Entertainment & Media, Auto & auto ancillaries and Logistics Sector in order to capitalize on strong growth potential or potential to earn, that may emerge in future. A ceiling of 50% of the total investible corpus would be imposed per sector in order to avoid concentration of investment.

The spate of FMPs in the past months are gradually on the decline with debt-oriented interval schemes taking over the reigns. ICICI Prudential and ING Mutual Fund have come up with debt interval schemes this month.

UTI - India International Fund, JM Multi Strategy Fund, Tata Banking Exchange Traded Fund, Birla Sunlife Special Situations Fund, HSBC Small Cap Fund, Kotak Focussed Sector Scheme and DSPML Natural Resources and New Energy Fund are expected to be launched in the coming months.

Gem gaze

The gems in the sectoral space take turns exhibiting their lustre. Their fortunes are intertwined with that of their sector so much so that perennial prosperity is the priced possession of a select few funds. Listen with rapt attention to the stories…

DSPML TIGER …. the ferocious fauna!

DSPML TIGER's growth-oriented, largecap, well diversified portfolio has helped it deliver good returns. There is a sage behind the aggressive façade that the name presents. An acronym for The Infrastructure Growth and Economic Reforms, the fund focuses on sectors that are likely to prosper from growth related to economic reforms and infrastructure development. Launched three years ago, the fund capitalised on the infrastructure run – a well-timed entry. Though telecom and power are the prime focus of the fund, its broader mandate enabled it to tap into sectors that core infrastructure funds do not - healthcare, FMCG, textiles. The portfolio is, probably, too well diversified at around 65 stocks. RIL, the largest holding, is currently at less than 6 per cent and the rest are all below 4 per cent. One can expect such diversification from a mid-cap fund, but this is surprising from a predominantly large-cap offering. Nevertheless, its tilt towards growth investing – GARP (Growth at a reasonable price) has enabled it to deliver superior returns.

Reliance Diversified Power Sector ….power-packed performance

The Fund is a classic case of being in the sweet spot at the right time. The pioneer and only fund in the power sector, Reliance Diversified Power has a proven track record, way ahead of its benchmark India Power Index. The Fund aims to exploit growth opportunities available in power sector in the country, driven by rising demand and scarcity of electricity in the country. India is facing electricity deficit of 9.3% and peak demand deficit of 13.9%. Besides, the government has launched an initiative to remove electricity deficit by 2012. This surely provides an upside for the companies engaged in power business.The fund adopts a blend of growth and value oriented buying strategy with a prime focus on mid-caps. The number of stocks held in the portfolio is fairly static at 18 with very little churn in the portfolio in view of the long term vision of the fund manager. The long and successful innings that the power sector promises is based on solid foundations and it is roses all the way for the fund…

Prudential ICICI Infrastructure…a stable star

ICICI Prudential Infrastructure has protected the downside well while growing at a fast pace. The fund exhibits discernible differences that set it apart from other infrastructure based funds. The fund's average exposure to basic and engineering stocks has been only 8.7 per cent as against an average of 20%! The fund is underweight on construction stocks relative to its peers. But its exposure to the banking sector is high. While essentially a growth-oriented fund, it has a substantial representation of value stocks. The fund has managed to strike an equilibrium between making contra bets and limiting its downside by maintaining smaller holdings. And this equilibrium has worked in the fund's favour, for it displays better resilience in a bear market relative to its counterparts. A relatively less volatile performance coupled with an optimally diversified portfolio, make the fund a good choice in the infrastructure space.

DSPML Technology ….the towering techie

DSPML Technology has performed well, delivering good returns with low volatility. The fund's buy-and-hold strategy has paid off well .When referring to sector funds, consistency is not what most people think of. But this fund aims at just that and has succeeded. It has consistently beaten the category average over the past five years. By being well diversified, restraining the number of mid-and small-cap stocks (44.35 per cent of its portfolio is in large-caps) and limiting exposure to single stocks, the fund has managed to deliver good returns at low volatility. In the past 36 months, the portfolio has had an average of 28 stocks. Allocation to individual stocks, barring Infosys which is currently at 16.48 per cent, is mostly restricted to a single digit (NIIT follows in the second place at 9.21 per cent). Its strategy has held it in good stead in the current turbulent market. In the past six months the fund’s assets under management have almost trebled! And this has come at a time when the IT sector is in a slump and its peers have been losing investors. This phenomenon should not come as a surprise since the fund has maintained a broader mandate of investing in media, entertainment, telecom and other technology enabled companies as possible investment avenues. The fund has managed to tide over this slump on the back of astute stock moves as well.

The moral of the stories is… ”Stick to the knitting“ does not pay off …the cushion offered by these funds have stood them in good stead.

FUND FLAVOUR

Sector Funds

Surfing on sectors …

Sector funds have a mandate to invest in just one sector. Currently there are nearly 40 sectoral schemes operating in the Indian Mutual Fund industry, catering to 7 sectors. The first sectoral scheme to be launched was way back in April 1994, by Apple Asset Management Company called Apple Goldshare. It was later taken over by Birla Mutual Fund. The scheme is now known as Birla MNC Fund. The latest entrant in this segment is Lotus Infrastructure Fund which is currently open for subscription. Indian Mutual Funds have funds focussed on banking, technology, FMCG (fast moving consumer goods), pharma, MNC and infrastructure, with the latter being more thematic than sectoral inview of the wider definition.

Banking Funds

The Indian banking sector is witnessing a fair amount of interest and activity.There are three banking funds today - Reliance banking, UTI banking and Benchmark Banking BeES. Lotus Banking Fund is to be launched soon. Five more Banking ETFs are likely to be launched in the near future, two from Kotak, two from Benchmark and one from Reliance.The reason is understandable-Benchmark's Banking BeES is a Rs 5,845- crore fund today. The banking funds have delivered eye popping returns - over 82 per cent over the past one year.The banking stocks picked up momentum after better 2006-07 fourth-quarter results and on expectation of no further hikes in interest rates by the Reserve Bank of India in the future. Of course the fund managers are waiting to read the contours in 2009 when the banking sector will be opened up. In view of the restrictions, foreigners are currently investing through bank ETFs.

Technology Funds

In the past, particularly during the TMT (technology/media/telecom) boom in 1999-early 2000, there was a flood of sector funds targeting the technology/software sector. While some of these sector funds had their place under the sun, most of them were caught wrong footed when the market rally ran out of steam in March 2000. As Technology funds slipped into the morass, seven survivors of the tech melt down rose like a phoenix from the ashes… Magnum IT, DSPML Technology, ICICI Prudential Technology, Birla Sun Life New Millennium, UTI Software, Franklin Infotech and Kotak Tech. Reliance Mutual Fund came up with Reliance Media and Entertainment Fund in 2004. Now the appreciating Rupee does seem to have hit the technology sector but it …ranks next only to banking and infrastructure funds.

FMCG Funds

Though the outlook for the FMCG sector remains bright given the growth in consumer spending and better results posted by the companies, the funds in this category have put up a dismal show on the returns front. The three funds in this category by Prudential ICICI, Franklin and SBI could pull out a return of only 10.45% over the past 12-months, and has, in fact, lost 2.63% in the past six-month period. The sector in general is suitable for investors with reasonable risk appetite and will provide decent returns in a consistent manner over long duration.

Pharma Funds

The health of pharma funds has never been as robust as other equity fund categories. However, these funds' relative performance among the universe of equity funds have improved over the past one year. Among the five funds in this category, the latest entrants, JM Healthcare Sector and Reliance Pharma, both launched in mid-2004, have dished out the best returns over the past one year. Among the older pharma funds, Magnum Pharma has been putting up a better show. With the deadline for complying with international norms coming closer, the removal of controlled price regime should augur well for fundamentally good and competitive firms in the sector. This sector is essentially for the investors who have a reasonably long investment horizon, as this sector will perform in fits and starts and the steady growth will be visible only in a longer duration.

Auto Funds

Automobile stocks seem to be losing steam in the recent past. UTI Auto and JM Auto, both launched in 2004, have been languishing at the bottom of the returns chart. The category has managed to achieve an annualised return of only 18.24% over the past two-years and has, in fact, lost 7.38% in the past six months. However, the performance of the two funds remain wide apart. While, JM Auto, which has a mid- and small-cap orientation, has delivered a decent return of almost 31% over the past one year; UTI Auto, with its predominantly large-cap orientation, managed only 4.28%.

MNC Funds

All mutual funds will feel the crunch as the number of MNCs decreases. But more so, MNC-specific funds like Birla MNC, Kotak MNC and UTI MNC. These three funds were launched in 1998-2000, when MNCs were doing well. Now, with an increase in the number of firms being delisted, their investment universe is restricted. There are about 60 companies, where the public shareholding is less than 25 per cent and another 22 companies where action in the form of buy-back, open offer or voluntary delisting can be expected in the coming months. Though the MNC funds will benefit from the buyback, they will have to exit from lucrative stocks and see their pie shrink.

The Infrastructure Funds

Three of India's top five performing funds in 2006 were pure infrastructure funds. Strong order-flow and increased policy and budget support from the Government augur well for earnings growth of companies in this space. Reliance Diversified Power Sector Fund, ICICI Prudential Infrastructure Fund, DSP Merrill Lynch T.I.G.E.R. Fund, JM Basic Fund (Energy), Birla Infrastructure Fund, UTI Infrastructure Fund, Tata Infrastructure Fund, Principal Infrastructure and Service Industries Fund, Sahara Infrastructure Fund, UTI Petro Fund, Can Infrastructure etc. are relatively new funds with only Tata and DSPML Infrastructure Funds having been in existence for at least two years. Most of the infrastructure related sectors in India, while offering tremendous scope for growth in the medium to long term, are plagued by several roadblocks including land acquisition, political interference and lack of concerted action backed by a clear vision.These problems are likely to prevent the sector from reaching its real potential within the next 2-3 years.

…an adventure worth it?

Whether it was the technology sector in the late 90s or the banking or infrastructure sector lately, sector funds have always caught investor’s fancy. In addition to returns, long-term approach, understanding the sector dynamics, non-expectation of extraordinary returns and risk tolerance capacity should be the watchwords of those who want to surf the sectors and make a killing!