FUND FULCRUM - OCTOBER 2008

FUND FULCRUM
(October 2008)

Tight times

The global financial crisis, particularly the turmoil seen in the US financial circles, has had its impact on the Indian capital markets as well. The Indian stocks markets witnessed a significant fall in September, the Sensex shedding nearly 12 per cent. The unpredictable markets, that seem to shake at the slightest provocation, have hurt the investors' sentiments and predictably the fortunes of the fund houses as well. In addition, September is the period when inflows into equity are generally tight as the banking sector has to redeem its funds on account of balance sheet concerns at quarter end. Most corporations also redeem their money to meet their advance tax liabilities.

In September, the combined assets under management of fund houses fell by 2.76 per cent. The assets under management of the mutual fund industry now stand at Rs 5,29,121.75 crore against Rs 5,44,173.95 crore at end of August. 20 of the 36 fund houses witnessed a dip in their AUM. All the top 10 fund houses have seen a steep decline in their assets. Reliance Mutual Fund retained the top slot in terms of assets under management even though its assets declined by two per cent to Rs 86,494 crore. HDFC Mutual Fund was the second largest fund house with assets worth Rs 51,998 crore, which was down by Rs 1,860 crore from the previous month. ICICI Prudential Mutual Fund, held the third position with assets worth Rs 49,772 crore even though it was a whopping Rs 3,320 crore less than the previous month. UTI Mutual Fund which held Rs 44,623 crore, after losing Rs 2,324 crore was the fourth largest in terms of assets under management.

Silver lining in the dark sky…

On a brighter note, some fund houses also saw a surge in their assets. Canara Robeco Mutual Fund saw its assets surge by nearly Rs 1,090 crore to Rs 6,006 crore. Sundaram BNP Paribas Mutual Fund added Rs 642 crore while Franklin Templeton Mutual Fund added Rs 632 crore to their respective AUMs. Apart from these, ABN AMRO Mutual Fund (Rs. 591 crore), Kotak Mahindra Mutual Fund (Rs. 389 crore) and Deutsche Mutual Fund (Rs. 228 crore) also saw a significant surge in their assets. Another notable development this month was that the new fund house, Edelweiss Mutual Fund declared its AUM for the first time which stood at Rs 301 crore.

Piquant Parade

At the annual Outlook Money NDTV Profit Awards, Principal Asset Management Company was declared the Best Mutual Fund House as well as the best debt fund house in India.

ABN AMRO Asset Management Company has been acquired by Fortis Investment Management and would be renamed Fortis Investment Management (India). This change comes after a consortium comprising of The Royal Bank Of Scotland, Fortis and Banco Santander acquired the entire share capital of ABN AMRO Holding in October 2007 and each member of the consortium acquired parts of ABN AMRO that best synergized with their business.

Tata Mutual Fund has entered into a strategic tie-up for the distribution of its funds with State Bank of Hyderabad. Under this new arrangement SBH will distribute the entire product range of Tata Mutual Fund schemes across 1,001 branches and 45 extension counters of the bank.

Regulatory Rigmarole

In what seems to be a victory for the Mutual Fund industry, mutual fund houses can now sell insurance cover bundled with mutual funds. The finance ministry has intervened in the dispute between insurers and fund houses to end a ban by life insurance industry providers on providing group life insurance covers to mutual funds. Insurance companies had planned to discontinue the offer of group life insurance cover on mutual fund products starting from Oct. 1, 2008.

Domestic mutual funds need to make more disclosures about the portfolios of their fixed-maturity plans (FMPs) to enhance investor confidence in such schemes, according to Crisil FundServices. This observation comes at a time when there has been a huge redemption from many FMPs because of concerns over the creditworthiness of many of the securities in them. If the credit quality of FMPs’ investments is strong, then investors have much to gain by holding these investments to maturity. In this situation, it is actually premature redemption, which could lead to sub-optimal returns.

The Securities and Exchange Board of India has widened the band for valuation of bonds, which is used to calculate NAVs of mutual funds. Funds could value a rated debt security with duration of up to 2 years between 150 basis points (bps) below and 500 bps above its value, up from a band of 50 bps below and 100 bps above. For securities with a maturity of more than two years, the range has been fixed at 100 bps below and 400 bps above its value, up from 25 bps below and 75 bps above the value.

This will not only bring in more efficiency while calculating net asset values of funds, but also help fund managers get a better price while exiting their investments in times of redemptions. Money market schemes, which invest in debt paper of a duration — generally less than one year — were facing large-scale redemptions by corporates and other institutional investors. The market turmoil had made it very difficult for fund managers to ascribe a value to bonds. So, in times of such redemptions, bonds often had to be sold at a loss. Fund managers can now hope for better prices while selling units of schemes, when investors seek their money back. Arriving at the NAV of these funds — the price at which investors exit or enter the scheme — has always been a challenge for fund managers, since there is no active market for most of these instruments.


The Reserve Bank of India cut CRR by 250 basis points (in tranches) and announced a scheme to provide liquidity to mutual funds. According to RBI’s scheme, banks are allowed to lend money to Mutual Funds against Certificate of Deposits (CDs) for a period of 15 days from October 14. Banks have also been permitted to buy back their own CDs from Mutual Funds. It is estimated that Mutual Funds hold Certificate of Deposits worth more than Rs one lakh crore. According to bankers, the problem is that most banks do not have excess SLR securities against which they can borrow in the repo market. And many banks are still on the borrowing side, as is evident from the RBI’s daily repo and reverse repo auctions.

Since the scheme was launched, banks have so far availed themselves of a total of Rs 8550 crore from RBI for lending to Mutual Funds. Two leading public sector banks have lent over Rs 3,500 crore to Mutual Funds so far, which includes the special repo window, other direct lending and by buying CDs from Mutual Funds. To further ease pressure, RBI will extend the liquidity window for mutual funds till further notice.

We are living in extraordinary times. The events that have unfolded globally have been far worse than anything the best risk managers could ever plan for. The deviation from the mean — in terms of change in human behaviour, widening of credit spreads, tendency to hoard cash and the scale of panic — has been of such magnitude that even the synchronised effort of multiple governments, central banks and policymakers have had little palliative effect. The tremors of the events in the US and Europe were felt as far as Singapore and Hong Kong where sovereign guarantees had to be issued to prevent flight of bank deposits. It is common wisdom that if all depositors withdraw their money in a bank together, leave aside the liquidity issues, the solvency of the institution will be at risk.Thankfully, for mutual funds the risk is one of liquidity alone.

NFO Nest
(October 2008)

NFOs go abegging…

Domestic fund houses are finding it difficult to get investors for their newly-launched schemes. Players like ICICI Prudential and Principal are extending the last date of their NFOs. This development has come at a time when the mutual fund industry was already grappling with a reduction in funds raised from new fund offers - for instance, during the June 2008 quarter, 146 new schemes raised Rs 29,799 crore, while a year earlier, 162 schemes raised Rs 38,653 crore, according to data gathered from the industry body AMFI. However, some of the fund houses like IDFC Mutual Fund and Bharathi AXA are putting a brave face. We are witnessing signs of a drying up of liquidity in the market given tax payments and other external factors.

The following funds find their place in the NFO Nest in October, 2008.

Principal Emerging Bluechip Fund

Opens: 22 Sept 2008 Closes: 20 Oct, 2008

It takes the brave to do something different and tread on the path less taken. And Principal Mutual Fund is one such brave fund house that has decided to swim against the tide. The AMC has launched the Principal Emerging Bluechip Fund that aims to invest in stocks of mid- and small-cap companies, and that too in a highly volatile market scenario where the mid- and small-caps are suffering the most. The fund will allocate 65-95 per cent of its corpus in equity and equity-related instruments of mid-cap companies, 5-15 per cent in equity and equity-related instruments of small-cap companies and up to 30 per cent in equity and equity related instruments of companies other than mid-cap and small-cap. While the fund aims to allocate 70-100 per cent in equity, up to 30 per cent allocation will be towards cash and money market instruments including fixed income securities. The fund will be benchmarked against the CNX Midcap Index.

DWS Gilt Fund

Opens: 7 Oct, 2008 Closes: 21 Oct, 2008

Deutsche Mutual Fund has launched DWS Gilt Fund, an open-ended gilt fund. The investment objective of the scheme is to generate reasonable returns by investing in Central/ State Government securities of various maturities. The scheme offers two plans viz. regular and institutional plan with dividend payout and growth option. The minimum investment amount under regular plan is Rs. 5,000 and under institutional plan it is Rs. 50 lakh. The fund will charge no entry load under both regular and institutional plan. The regular plan will charge 1 per cent exit load if redeemed before 12 months. The fund will be managed by Mr. Nitish Gupta and is benchmarked against I – Bex.

Goldman Sachs Sustain Fund, UTI Wealth Builder Fund Series II, Edelweiss Gilt Fund, Birla Sun Life 130 30 Fund, Religare Aegon Liquid Fund, Religare Aegon Liquid Plus Fund, ICICI Prudential R.I.G.H.T (Rewards of Investing and Generation of Healthy Tax Savings) Fund, Fidelity European Dynamic Growth Fund and Fidelity Global Industrial and Natural Resources Fund are expected to be launched in the coming months.

GEM GAZE - OCTOBER 2008

Gem gaze

The gems in the sectoral space continue to exhibit their lustre despite the radical changes on the diversified equity front and the stock markets…

DSPML TIGER Gem

DSPML TIGER with its impressive performance has seen a tremendous asset rise. There appears to be continuity in holdings in a significant portion of the portfolio while the balance is frequently churned. Out of the universe of 171 stocks invested in since inception (May 2004), 51 have appeared for less than six months. Stocks like Reliance Industries, ICICI Bank, L&T and BHEL have been long-time favourites. This large-cap tilted fund appears bloated with 60 stocks, but is an improvement from 72 (September 2007). The top five holdings comprise only 20% of the portfolio, while the figure is 35.75% for the top 10 holdings put together. Among various sectors, the fund has the largest exposure in energy (16%) and financial services (15.24) companies followed by basic engineering (11.36%), services 11.03% and metals & metal products (10.85%). The broad investment mandate, large-cap tilt, intense diversification and attractive returns have resulted in its asset base rise by 254 per cent last year.

Reliance Diversified Power Sector Gem

Reliance Diversified Power has not only generated returns superior to most other equity funds but has also demonstrated consistency in performance since its launch in April 2004. The fund’s return of 60 per cent since inception far outpaces its benchmark’s (India Power Index) return of about 40 per cent. At close to Rs 2,300 crore, the assets under management are significant but spread across only 18-20 stocks. Power generation is monopolised by the public sector and there are simply not enough sound power companies available. If the fund manager is restricted by the investment universe, he has ample flexibility on other fronts. His mandate actually permits him to invest the entire portfolio in not only equity, but also entirely in fixed income securities (of power companies and those related to the power sector). So this equity offering can well turn into a debt fund. With the mandate to even go 100 per cent in cash and equivalents, the cash holdings are significant if the fund manager does not find good investment opportunities. What is interesting is that the high cash holding has not dented the fund's performance. The fund manager is not restricted by market capitalisation either. While power stocks have undergone re-rating in valuations during the market rally in 2007, a good number of them have been beaten down during the recent market correction. However, unlike a few other sectors that are unlikely to regain their premium valuations, stocks in the power space continue to hold high earnings potential given the current macro scenario. For one, the peak power deficit situation remained at a high 14.6 per cent even as recently as the April-June quarter. This has prompted a recent revision in the capacity addition programme under the Eleventh Plan (up by 15 per cent to 90,000 MW). The additional planned capacity translates into new business for the entire spectrum of power companies. Two, even as the country failed to add even a single megawatt of nuclear power capacity between April-July (according to the CEA report), the waiver received from the Nuclear Suppliers Group is expected to throw open new opportunities. With prospects for the sector appearing strong over the next couple of years, this fund may be a good vehicle to ride the energy theme.

Prudential ICICI Infrastructure Gem

ICICI Prudential Infrastructure Fund, grabbed the top rank, with eight Indian equity funds ranking among world's top 10 best performing infrastructure funds in 2007, according to fund tracker Lipper. Over the past one year, the fund pruned exposure to sectors such as ferrous metals, construction, capital goods and oil. The power sector, which is expected to witness huge capacity additions, appeared to be the fund’s favourite as it nearly doubled allocation to this segment. It accumulated stocks such as NTPC and Tata Power over the past six months, resulting in a four-fold increase in holdings in each of the stocks. Allocation to banking space appeared sizeable in comparison to peers. Reliance Industries, a preferred stock for many a fund house, saw increased weight of 9.2 per cent to enter the fund’s top 10 holdings. The ferrous metals sector has been viewed cautiously by the fund. Allocation to the construction sector has not moved much relative to the increasing asset size while holdings in the cement space increased marginally. Bharti Airtel was the lone stock to represent the telecom space even as its holdings over the past six months almost doubled. These moves have stood the fund in good stead, the volatile markets notwithstanding.

DSPML Technology Gem

Despite the pounding that IT stocks received in the past one year, DSPML Technology has delivered strong returns, vis-a-vis its benchmark — BSE Tech — which it has bettered over one, three and five-year periods, making it the best performing technology fund. The fund has managed to beat its category convincingly time and again as a result of fund manager Apoorva Shah's radical moves. Faced with an appreciating rupee and fears of a U.S. downturn, he reduced the allocation to software service export companies and began to increase it to service and media stocks like Educomp Solution, Tata Teleservices and NDTV. The fund’s 82 per cent exposure to technology (January 2007) fell to 57 per cent (January 2008) while services (including media) were up at 32 per cent. The fund appears to have picked up stocks that have lower US centricity and those with lower exposure to the banking and financial services vertical. The other noticeable trend is exposure to companies in the fast-growing domestic IT training segment. Last year, it also steadily reduced its position in large caps and in March 2008, the mid- and small-cap exposure was at 72 per cent. The moves paid off well and the corpus of the fund swelled by 437 per cent last year. Infosys, TCS, Tech Mahindra, Rolta and Mphasis are among stocks that have stayed on. The portfolio consists of 49 stocks currently. Those interested in the telecom, media, technology and technology enabled sectors must give this fund a serious consideration.

The broad investment mandate and tactical moves by these gems have ensured perennial prosperity and enabled them to hold on to their esteemed status! Investors with an appetite for risk and a long term perspective can adorn their portfolio with these GEMs.

FUND FLAVOUR

Sector Funds

Marketing via Returns machine

The media and the recent return charts have struck a chord with investors who are keen on adding a sector fund to their portfolio. The marketing gimmicks kindle investor fancy. In reality, sectoral funds have seldom given returns higher than the Indian stock market. These funds are not known to outperform the blue-chips belonging to the sector they focus on. The indices designed by stock exchanges to track sectors such as the Bombay Stock Exchange’s BSE Pharma or BSE Auto too comfortably beat returns from sectoral funds that invest in the stocks belonging to the same industries. There are very few funds that have managed to buck the trend. The information and technology sector funds are the only ones that have beaten both the Sensex and the BSE IT Index over the last five years. The infrastructure and banking boom have been a recent and short-lived phenomenon.

Banking Funds - Bubble or Buoy?

While the financial crisis has felled several international banking giants, closer home, it is the banking sector funds that have outperformed all other categories of funds over the last three months. Seven of the 10 top performing mutual fund schemes during the July-September quarter were banking schemes. Three funds focused on the financial and banking sector have filed their offer documents with SEBI - HSBC Banking and Financial Services Fund, SBI Magnum Sector Funds Umbrella (MSFU) - Banking and Financial Services Fund and ABN AMRO Banking and Financial Services Fund. Sundaram BNP Paribas Financial Services Opportunities, Reliance Banking ETF, ICICI Prudential Banking and Financial Services Fund, Lotus India Banking and Sahara Banking and Financial Services were launched in 2008. This sudden enthusiasm for the financial sector seems paradoxical considering the fact that questions are being raised at the financial institutions both domestically and globally on how they are managed and why they have hidden the risk associated with some of their products. So, why are we seeing so much interest in financial and banking sectors and that too now of all times? One reason could be that in the past one year, net assets of the existing banking funds have grown at the rate of 24 per cent overshadowing that of other sectors. This shows that the banking funds have been able to hold the attention of the investors. The fund companies are launching financial funds responding to investors' fondness to this sector. The launch of too many specific sector funds could be a time to keep away from them. Remember how technology funds betrayed our trust in 2001. High time we learnt our lesson.

Technology Funds - Cash Fails to Rescue…

Year 2008 may end on a jarring note for technology sector fund investors. With a slew of negative news for the sector, technology funds hit a fresh low with ICICI Prudential Technology Fund and IL&FS eCOM Fund plunging by more than 50 per cent from their IPO price of Rs 10. The fall in technology counters has been so rapid that even a large cash position in most funds has failed to stem the slide in net asset values. The average cash holding was an uncharacteristically high 16 per cent with some funds holding more than 20 per cent of their assets in money market instruments. There are currently two schools of thought on the impact of the US slowdown on Indian IT companies. Nearly 50 per cent of the Indian IT industry's turnover during the first half of the current fiscal had come from the US market. A section of the market believes that the slowdown will adversely impact the Indian IT sector while another segment opines that a cut in IT spending will benefit the Indian industry as US corporations seek to reduce costs by outsourcing more IT related activities. Currently though, it is the first line of thought that continues to dictate the market movement. The top rung technology companies may not earn revenues in excess of 70-80 per cent but they are sure to maintain growth at a healthy pace in future and outperform other sectors of the economy.

Pharma Funds - Health Blues

The pharma sector has proved to be a laggard in the past one year. There are currently five pharma funds in the industry, managing overall assets of Rs 351 crore. All of them together delivered an average return of 9 per cent, underperforming the index.

Auto Funds - Overheated Engines

As concerns about the auto sector seem to be mounting, the funds dedicated to this sector are feeling the heat. Auto sector funds are at the bottom of the equity category - they rank even below the debt funds. The reasons for the poor performance of the sector are not difficult to find. Interest rates touched a five-year peak and this hit the auto sector which is very interest rate sensitive. This resulted in a slow-down of the demand for cars and sport utility vehicles in the country, where majority of the vehicles are bought on credit. The RBI diktat to banks on January 31 2008 to curb lending and investment to check inflation also proved to be a major deterrent for the first timer buyers. Total sales of cars, trucks and two-wheelers declined in the first quarter of the current financial year. The slowdown has been more visible for two-wheeler companies like Hero Honda, Bajaj Auto and TVS. Consequently there had been a sharp decline in the share price of the top auto companies this year.

Infrastructure funds - a safe haven?

One way of staying away from the volatility of the market, and still betting on the growth story of India, will be investing in infrastructure funds. Infrastructure funds have ruled the roost in the rally with almost all the funds doling out handsome returns over the year. These funds invest in companies that are a part of perennial sectors like construction, energy, telecommunications, power etc..., which hold the key to development of any economy around the world. These sectors enjoy maximum government support for development due to high gestation periods, huge investment outlay and primarily because the country`s growth relies on these sectors. At present, there is a wide gap between the potential demand for infrastructure and the available supply. This is a challenge before the economy, and the government through private-public partnerships and FII participation, is trying to fill in the gap. The increased government impetus on infrastructure development and the superlative performances of the corporates provide a window of opportunity to Infrastructure funds. But the 2008 market meltdown has crushed this citadel as well.

Precarious nest egg

Besides the tendency of sectoral funds to underperform as discussed at the outset, investment in them makes little sense for two other reasons. One, their narrow investment objective raises the risk they carry. They, thus, defy the basic principle of mutual fund investment — of diversifing risk by not keeping all eggs in one basket. And two, investors must make no mistake in deciding when to enter and exit these funds, which, again, is in direct contrast to the convenience that mutual funds are supposed to offer. Lack of diversification and dependence on timing makes sector funds a risky proposition. With the days of heady returns way behind us, advocating investment in sectoral funds, even to those brave of heart, would only kill and not make a killing!