FUND FLAVOUR
 
September 2015

Diversified equity funds invest across market capitalizations and sectors. Such active diversification ensures that the negative performance of one sector does not affect the entire portfolio and increases the possibility of making a sustainable return. These funds aim for medium to long term capital appreciation and are suitable for investors having moderate risk profile and investment horizon of at least three to five years. The investments of these funds could be vertical in nature where various sectors and a mix of the various market caps are considered for investments. Diversified equity funds with vertical investments tend to be more diversified than horizontal investments as it provides sectoral and market cap diversification and provides better cover against risk. Across the industry, diversified funds are also known as multicap funds, flexi cap funds or large and midcap funds. Having too many large cap funds in your portfolio could stagnate your investment returns. Investing solely in mid and small cap funds could make your portfolio volatile and risky. Diversified equity funds are that middle path which allows you to invest in all the market caps through one fund.

Raison d’ etre

Stability in bull and bear markets

Diversified equity funds comprise of stocks of all market caps. Large cap stocks exhibit minimal response to appreciation in bull markets or depreciation in bear markets. Mid and small cap stocks respond to market stimulations. While, they show higher appreciation in bull markets, their depreciation is in sync with the bear markets. The differences in the performance of these market caps get balanced in diversified equity funds. In a bear market, the mid and small cap stocks have a tendency to be volatile even if the large cap stocks show moderate depreciation, thereby maintaining a steady balance. It is this stability which allows investors with a varying risk appetite to park their investments in these funds.

Reduces the need to diversify

Financial planners and advisors keep emphasising about the need to diversify your investments. It is said that diversification in various asset classes determines the return of the portfolio and not the individual funds. Investing in diversified equity funds reduces the need to diversify your portfolio as you choose an already diversified fund depending upon your investing needs and risk taking ability. As an investor if you are looking for stability in your investments, you could allocate a larger portion of your investments in diversified equity funds and the remaining in small and mid cap funds. However, if you are an aggressive investor and ready to take high risk for long term appreciation then mid and small cap funds could be ideal investments for you.

A universal appeal

Diversified equity fund has a component to appeal to all kinds of investors: the risk taker, the safe player, and the flexible investor. Hence, as an investor if you like to manage your own portfolio then this reduces your need to diversify to a certain degree and it provides stability to your portfolio along with a moderate to high return.

Pick the grains from the chaff

As an investor this is probably one of the most crucial decisions to make. There are too many schemes within the same category and all of them sound equally appealing. Each either has a high rate of return or promises to deliver so in future. All of this could be intimidating and confusing. Needless to say there are various factors that have to be taken into account: the historical performance, the returns generated against the category and the benchmark index. Let us examine the nuances of these aspects and make this process of selection a little easier for you.

Compare the fund returns against the diversified fund category return and benchmark: A fund that has been in market for a considerable period of time will have a track record of returns over the years. Compare that return to the returns of the diversified equity mutual fund category and the benchmark associated with the fund. The category returns are projected after taking into account an average of returns of all the schemes under that category. For example, if the return of a diversified equity fund over ten years has been 22% annualised and the category return over the same period has been 18% annualised then the scheme has outperformed the category returns. Now, you need to check the performance of the fund against which it has been benchmarked – For example, S&P BSE 100, S&P BSE 200, CNX 200, CNX 500, etc. Majority of the diversified equity mutual funds in India are associated with these four benchmarks. If you find that the fund chosen by you has outperformed both – the category returns and the benchmark then you can consider the fund for investing.

Check the consistency of the chosen diversified equity fund: A diversified equity mutual fund can consist of large, mid and small cap stocks in its portfolio. Hence, the fund managers can choose stocks from different sectors and market caps. As an investor it could be difficult for you to track the sectors or stocks within your chosen fund. Therefore, to check the consistency of the returns you should look at two things - the historical returns of the fund and the volatility of the selected fund across different market cycles.

The scorecard

Year 2014 has been a year of revival for India's equity mutual fund investors. Most of them are back in the black after witnessing wealth erosion for nearly three years. A typical mutual fund (equity) investor has seen 61% (median) rise in the value of her investment in the last one year, higher than any other asset class. And the momentum continues with net asset values (NAVs) up 12% in the last three months. It has boosted funds' long-term performance. As many as 173 out of 202 schemes in the diversified fund universe have given 15% annualised returns in the last three-years. The analysis is based on all open-ended equity schemes with a five-year performance record. The secular trend in the industry is positive but there is a great variation in performance across various market capitalisation categories. The biggest gains went to investors who stuck to "riskier" mid- and small-cap funds. They have nearly doubled their capital (92%) in the last 12-months, nearly twice the returns bagged by investors in large-cap funds (50.2%). Other classes of diversified equity schemes are in the middle. Trends in the last three months suggest that the momentum favours mid and small-cap funds. Diversified equity funds, which comprise of both large cap and mid cap stocks, have done even better. Diversified equity funds as a category have beaten the CNX 500 index and given average returns of more than 31% in the last 6 months. Within the large cap and diversified equity funds categories some funds have done exceedingly well and given very high returns to their investors in the last 6 months.

The evergreen fund

Equity as an asset class is vast and has various categories of investments, diversified equity funds being one of a kind where investors need not individually diversify the various investments. It is that kind of equity mutual fund where one can invest and expect returns ranging from moderate to high and suitable for beginners and moderate risk takers. Historically it has been seen that long term investments in diversified equity funds have beaten the returns of bank fixed deposits, gold, and PPF with a decent margin. There are no iron clad promises in investing. A fund, no matter how safe or risky, could always surprise you and diversified equity funds are not an exception but certainly enjoy universal appeal.