FUND FULCRUM
(May 2009)

Mutual funds are breathing easy. After seeing a net outflow of Rs 28,297 crore in 2008-09, inflows of Rs 1,54,192 crore were seen in April, 2009 according to data from the Association of Mutual Funds in India. The numbers from 2008-09 reveal some interesting facts. For instance, while there was erosion in the markets, equity funds actually saw net inflows worth Rs 1,056 crore. Fund categories which witnessed maximum outflows during that period were income funds and liquid funds. The number of Systematic Investment Plan accounts fell to 3.26 million by March, 2009 from 3.62 million in September, 2008. Volatile markets coupled with the liquidity crunch have taken a toll on the performance of India’s top five AMCs. Reliance, ICICI Prudential and UTI AMCs have recorded a fall in profits by 16%, 99% (on account of the write off of its exposure to the Subikhsha chain) and 16% respectively. But HDFC AMC and Birla Sunlife AMC have witnessed a rise in profits by 15% and 49% respectively.

The mutual fund industry surpassed the 5 lakh crore mark in assets after a gap of two months. The mutual fund industry’s total AUM increased by Rs 58,013 crore or 11.76%. The combined average AUM of the 35 fund houses in the country increased to Rs 5,51,299.95 crore in April, 2009 compared to Rs 4,93,286.56 crore in March, 2009 according to the data released by AMFI. Reliance Mutual Fund maintained its position as the largest fund house with a jump of Rs 7,425 crore in its AUM to Rs. 88,387 crore. HDFC, the second largest fund house, gained Rs 5,924.18 crore in its AUM at Rs 63,880.63 crore. Smaller fund houses, which have seen a significant rise in AUM include Baroda Pioneer (66%), Taurus (65%) and DBS Cholamandalam (57%).

Income schemes (including liquid funds) pulled in a record Rs. 1,03,055 crore in April, 2009 according to AMFI. The major contributors have been banks which seem to have parked their surplus funds in this short-term avenue. The average returns from a liquid fund for the duration of 45 to 90 days ranges from 4.5 to 5% at present. This is approximately 125 basis points higher than the returns offered by RBI. As long as this gap remains, there is scope for banks to earn something on the liquidity which is aplenty given the slowdown in the credit off take.

Piquant Parade

The mutual fund industry, which went into hibernation last year, is back with a bang. Currently, there are 20 mutual funds lined up with SEBI for mutual fund licenses. These include Axis Bank, India Bulls, Future Finance, Peerless, Schroders, Sanlam Investment Management etc.

With the clouds of gloom gradually lifting up, IDBI Bank is planning to enter the Indian mutual fund industry. It is interesting to note that IDBI had an AMC in joint venture with the Principal Financial group way back in 2000. However, in 2003, it exited the joint venture by divesting its 50% stake in the IDBI-Principal AMC to the joint venture partner for Rs 95 crore.

Union Bank of India, in joint venture with Belgium-based KBC group, plans to enter the mutual fund business by December, 2009. It hopes to receive SEBI approval by 30 June, 2009. Union Bank is expected to hold 51% stake while the rest will be held by KBC. The bank plans to change its 200 branches as dedicated centres for the mutual fund operations.

Motilal Oswal Financial Services is planning to launch its first mutual fund scheme by the next quarter of this fiscal through its investment arm Passionate Investment Management Ltd.

In view of its sub prime exposure, Shinsei may exit its mutual fund venture in India. It is believed to have initiated talks with Indian Bank to sell its stake.

UTI AMC will rope in a strategic partner with 26% stake. There will be no capital infusion into the company this time. The four stakeholders, SBI, LIC, PNB and BoB, will shed 6.5% of their stake each. Their stake after this exercise will stand at 18.5% each. T Rowe Price, Schroders and Vanguard are said to be in the race to acquire stake.

IDFC Mutual Fund has signed a strategic alliance with Bank of India to distribute and market mutual fund products through its branches.

UTI AMC is planning to launch a mobile phone-based platform to allow investors to buy, sell or switch money into its products as it plans to tap young and tech savvy investors.

UTI AMC and Invest India Micro Pension Services have concluded a strategic partnership with the Basix group to deliver UTI’s Reirement Benefit Pension fund to Basix customers. Basix is a leading livelihood promotion institution that works with over 1.5 million poor – 90% of whom are rural households and the rest urban slum dwellers.

Birla Sunlife AMC has been adjudged the best “India Onshore Fund House” at the Asian Investor 2009 Investment Performance Awards. It grew by 31% year-on-year, while the overall industry registered a downfall of 7% in the average AUM in the past financial year.

Regulatory Rigmarole

Several top performing funds are merging smaller schemes or changing the investment objectives of schemes to make them broader. Portfolios are being merged so as to cut costs and improve performance.

AMFI had asked the mutual funds to declare 18 May, 2009 as a non-business day and not honour sale or redemption requests given a surge in stocks that led to a trading halt.

The Supreme Court is expected to decide as to whether selling mutual fund products is a taxable service or otherwise. The Commissioner of service tax has filed an appeal with the Supreme Court since it is of the opinion that sale of mutual fund products amounts to service for the purpose of levy of service tax.

The pros and cons of imposing variable loads on mutual funds is still being debated by stalwarts in the industry.

With the Indian electorate having given a near-decisive mandate, the stock-markets skyrocketed. The portfolio of the long-term investors has entered the green territory.

On this positive note, let me decelerate the pace of blogging…yes it is vacation time again… FUND FULCRUM alone will still make its appearance on the last Monday in the ensuing three months…The regular features will commence from September, 2009.

NFO Nest
(May 2009)

Debt Fund domination continues…

With security at the top of the agenda of every investor, the debt flavour of NFOs is being maintained. The latest market euphoria, if sustained, could alter the existing equation and equity funds could rise like phoenix from the ashes…

The following funds find their place in the NFO Nest in May, 2009.

Morgan Stanley Short-term and Active Bond Fund
Opens: 12 May, 2009

Closes: 20/25 May, 2009

The launch of Morgan Stanley Short-term bond fund and Morgan Stanley Active bond fund marked the debut of Morgan Stanley Mutual Fund’s fixed income boutique in India and continues the firm’s expansion in India’s investment management industry. The investment objective of Morgan Stanley Short Term Bond Fund is to generate income from a diversified portfolio of short to medium term debt and money market securities and will be benchmarked against the CRISIL Short-Term Bond Fund Index. The Morgan Stanley Active Bond Fund will seek to generate optimal returns through active management of a portfolio consisting of debt and money market securities. It will be benchmarked against the CRISIL Composite Bond Fund Index. Interest rates are at a cyclical downturn on the back of global economic slowdown and low inflation. Given this environment, Morgan Stanley Short Term Bond Fund will be well positioned to take advantage of any fall in short term interest rates. Morgan Stanley Active Bond Fund will be actively managed to take advantage of any fall in the overall interest rate structure. A flexible investment strategy is best positioned to generate an optimal risk adjusted return, given the market opportunities.

Canara Robeco Dynamic Bond Fund
Opens: 4 May, 2009

Closes: 20 May, 2009

Canera Robeco Dynamic Bond Fund is an open-ended debt fund that seeks to generate income from a portfolio of debt and money market securities. The scheme will invest upto 0-70% in government of India and corporate debt securities including securitised debt and excluding Debt/GOI securities with initial maturity of less than one year and Treasury bills. The scheme will invest 30%-100% in money market instruments. Investment by the fund in securitised debt will not normally exceed 50% of the net assets at the time of investment. Investment by the fund in derivative instruments may be done for hedging and portfolio balancing up to 30% of the net assets at the time of investment. The fund will be benchmarked against the CRISIL Composite Bond Fund Index. Its primary objective is to actively manage the interest rate risk of the portfolio. The fund endeavours to trade duration to generate alpha for its investors by adopting a proactive strategy of encashing on interest rate fluctuations under any market condition. Thus, the fund will benefit from the opportunities provided by the inefficiencies and volatility in the fixed income market.

Tata SMART Investment Plan-1
Opens: 27 April, 2009

Closes: 1 June, 2009

Tata Smart Investment Plan-1 is a 36 months closed-ended hybrid scheme that seeks to generate returns by investing systematically in equity and equity related instruments. The scheme aims at investing 0% to 100% in equity and equity related instruments and 0% to 100% in debt, money market and securitized debt instruments during the first twelve months and twenty four months from the date of allotment in the case of Scheme A and Scheme B respectively. After the above-mentioned period in the respective schemes, investment will be 65% to 100% in equity and equity related instruments and 0% to 35% in debt, money market and securitized debt instruments. The performance of the scheme will be measured against CRISIL Liquid Fund Index and the BSE Sensex based on the proportionate weightage of equity and debt in the scheme’s portfolio.

IDFC Nifty Fund, Raliance Gold Savings Fund Scheme, Baroda Pioneer PSU Bond Fund, Shinsei Industry Leader’s Fund, Sahara Daily Fund and DSP Blackrock World Energy Fund are expected to be launched in the coming months.

GEM GAZE - INDEX FUNDS

GEM GAZE

Index Funds

Lauded in times of lull…

Investors, who embraced index funds in 2008, when the financial crisis had reached a crescendo, are now pointing their index finger towards index funds blaming them for their mediocrity. Little do they realise that it is this factor that mellowed down the ill effects of the crisis while equity funds faced a steep slide.

Only two index funds have exhibited performance worthy of a gem in the past 12 months. The others have fallen short of expectations.

Benchmark Banking BeES

Fall from grace…

From enjoying the status of a fund with the highest AUM last year (Rs. 4253.4 crores), Banking BeES has undergone a steep downward spiral to Rs. 2744 crores in September 2008, Rs. 559 crores in January 2009 and a paltry AUM of Rs. 107.4 crores in April 2009. The financial crisis has had a telling effect on the fund’s performance but the recent rally bodes well for the fund. The one-year return was a negative 27.83% in 2008 but the latest one month performance of 20.63% as against the category average of a mere 10.58% has more than made up for it. But the question of sustainability remains…

ICICI Prudential Index Fund

Active passivity…

ICICI Prudential Index Fund has graduated to a new level by allowing for an exposure (nearly 16 per cent) to derivatives. By using index and even stock futures, the fund has given some sort of respite to its investors. But by doing this the passively managed approach of index funds have been rendered meaningless. The one-year return has been a negative 27.22 %. But the one-month return during the recent rally has been 8.15% as against the category average of 10.58%. The tracking error is 3.19% for 3 months and 2.91% for six months. The AUM has shown a marginal increase over the previous year to Rs. 43.37 crores in April 2009. The expense ratio is 1.25% while the portfolio turnover ratio is 379%, the highest among all index funds.

Birla Index Fund

Crushed under cash…

With an AUM of a meagre Rs. 30.43 crores, the performance of the fund over the one-year and one-month periods at -29.30% and 8.19% have been worse than the category average of -29.19 and 10.58 percent respectively. Birla Index Fund has 25 per cent of its net assets in cash. Holding cash in an index fund is a double edged sword. If the benchmark scrips go up, the fund will lose out on returns. But if the scrips go down, the fund will fall less as compared to the benchmark. The expense ratio is 1.5% and the portfolio turnover ratio is 150%.

Can Robeco Nifty Index Fund

The underdog…

The AUM of the fund in April 2009 stands at Rs. 4.98 crores. While the one-year return is slightly better at -29.03 % compared to the category average of -29.19 %, the one-month return is worse at 8.15 % compared to the category average of 10.58 %. The scheme underperformed the Sensex over most of the time periods. The expense ratio is 1.01% and the portfolio turnover ratio is 4%.

Franklin India Index Fund Gem

Golden glitter…

This ICRA 5-star gold award winner 2009 in the one-year and three-year categories, has an AUM of Rs. 80.57 crores. The one-year and one-month returns are -28.98% and 8.21% respectively. The expense ratio is 1% and the portfolio turnover ratio is 24.93%.

Principal Index Fund

Pathetic performance…

The fund’s AUM stands at Rs. 21.88 crores. The fund’s performance has fallen short of its category average. Its one-year and one-month returns are -30.32% as against the category average of -29.19% and 7.93% as against the category average of 10.58%. The expense ratio is 1.49% and the portfolio turnover ratio is 37%.

UTI Nifty Index Fund Gem

On an award winning spree…

It has been ranked a Seven Star Fund by ICRA and has been awarded the Gold Award for best one-year and three-year performance in the category of Index Equity funds for the year ended 31 December, 2008. The AUM was Rs. 200.98 crores in April 2009. One-year and one-month returns are -28.98% and 8.01% respectively. The expense ratio is 1.34% while the portfolio turnover ratio is 9.13%.

Tata Index Fund

Run-on-the-mill…

The AUM of the fund in April 2009 was a mere Rs. 6.77 crores. The one-year and one-month returns have not been impressive at -29.39% and 8.12% respectively. The expense ratio is 1.5% and portfolio turnover ratio is 19%.

LIC Index Fund

Lacklustre performance…

The one-year and one-month performance of LIC Index Fund has been lacklustre. The returns were -30.66% and 7.69% respectively. The fund has the dubious distinction of having the highest tracking error. The tracking error for the fund is as high as 9.38 per cent for the three-month category and 10.54 per cent for the six-month category. For the one-year and two-year category the error is somewhat less, but still glaring, at 7.53 per cent and 5.74 per cent, respectively. The AUM of the fund is Rs.84.28 crores. The expense ratio is 1.5% and the portfolio turnover ratio is 10%.

ING Vysya Nifty Plus Fund

Worsening by the day…

The one-year and one-month returns are -28.40% vis-à-vis the category average of -32.71% and 7.88% vis-à-vis the category average of 10.11% respectively. The AUM of the fund is Rs. 8.4 crores. The expense ratio is very high at 2.5% and the portfolio turnover ratio is 12.64%.

Magnum Index Fund

Hyperactivity takes its toll…

The one-year and one-month returns are -30.27 and 8.37% respectively. The AUM of the fund is Rs. 16.48 crores. The expense ratio is 1.5% and the portfolio turnover ratio is 174%.

Index funds, in general, do not enjoy as much recognition as their equity counterparts in India. The financial crisis temporarily altered this scenario. The steep fall in the AUM of index funds (thanks to the recent rally!) compared to the previous year bears testimony to the fact that index funds still meet step motherly treatment from Indian investors.

FUND FLAVOUR - INDEX FUNDS

FUND FLAVOUR
(May 2009)

Index Funds

The slow but sure tortoise…

The active versus passive debate in investing started almost 50 years ago when the Efficient Markets Hypothesis (EMH) was unveiled. The more efficient the market, the more difficult it is to generate returns in excess of a broad index. The passive investor who believes in EMH ensures the default market return by investing in the index over the long term to smoothen volatility. The active investor tries to beat the market by creating a stock portfolio and timing entries and exits to coincide with ups and downs. It is tempting to be active because no market is perfectly efficient. There will always be imperfections that a smart investor may exploit. But few people beat the market and even fewer do it consistently. That evidence is strongly in favour of the EMH. When it comes to mutual funds, the entire class of index funds was created with passive investors in mind. This tortoise of the mutual fund industry is slow but sure.

Mirroring the index…

The mandate for an index fund is simple: mirror the index. The fund manager has to own index stocks in exactly the same ratios as their weights in the index. If there is a change in the index population or in weights, the fund must rebalance. Stock indices are either un-weighted or weighted according to some formula of market capitalisation. Whatever the formula, rebalancing weights of an index fund with no change in population, is a mechanical task of maintaining even-number ratios. It is more delicate if there is a split or a new company is inducted.

Key Measures of Performance

Index fund investors need to look at three key measures of fund performance. One is low-cost. The second is liquidity. The third is the deviation of the index fund's return from the actual index return. The first and second measures are driven by competition. So an index fund must have low-load and low expense ratio. Since there are many competing index funds, they all offer reasonable liquidity and reasonable expenses. The third measure is the ‘tracking error’ (TE) and this must be minimised. An ideal index fund would offer zero tracking error and mirror index return exactly. While this is obviously impossible, a good index fund will keep TE below 0.5%. Tracking errors are understandable when there are big changes in index population. They are also normal in the first few months of an NFO. They can also be caused by a scenario of massive redemptions or by an influx of cash if new units are being issued.

Benchmark is the only Indian AMC that is totally focussed on passive investing. It offers index ETFs that have TEs of less than 0.5%. Among the other AMCs, many have month-on-month TEs of over 3% and very few have stayed under the 0.5% threshold. Errors of 2-3% level cannot be brushed aside in view of the compounding effect and the fact that index fund investors are generally long-term players. For example, an investor with a 3% annual TE and a 3-year investment timeframe may see absolute return deviate by 15% from the index return. Why has this happened with well-established fund houses? We see two persistent problems with portfolios of high TE funds. The first is that there are some differences in their portfolio-weights, compared to the index-weights. The second is a higher level of cash assets than desirable. The portfolios weights are generally not very different from the index weights. But even small changes can cause relatively large TE. The second cause for deviation is easier to understand. Apart from Birla Sun Life, which has a massive 25% in cash, there are several others (ICICI and Magnum) with double-digit cash. Most index funds hold around 3% in cash. For an open-ended fund, this is not an unusual cash-level because of redemption contingencies as well as possible inflows from the issue of new units. But even 3% cash seems enough to guarantee significant TE. The Benchmark schemes generally have between 0.5-1.5% of assets in cash and they appear to have gained from a structural advantage of ETFs over open-ended funds. Benchmark offers the only ETFs, while the other index funds are all open-ended. ETFs need not worry about cash redemption. Units are traded on the exchange and if at all, units are extinguished, underlying shares are offered in exchange, rather than cash.

One up on Diversified Equity Funds…

The steep decline in the equity market in 2008 has wiped out a large part of investors’ wealth, irrespective of whether they took the direct investment route or went through mutual funds. In a volatile market such as the present one, predicting short-term movements and timing the market, despite the steep corrections already witnessed, remains a challenge. In uncertain times investing through index funds may be a better option if one prefers to go with the market tide. The one-year return clocked by the index funds is between -41.5 and - 47.5 per cent, as against BSE Sensex and S&P Nifty decline of 54.7 per cent and 54.3 per cent respectively. The divergence between the benchmark performance and the index funds is due to tweaking of the portfolio with minor changes in the weight of stocks held and cash position of the funds. During the same period diversified funds have declined in the range of 34-74 per cent.

…and its more aggressive cousin – Sector Funds

Most sector-based mutual fund schemes have fared worse than their index counterparts during the past six months. These funds might have performed worse than their corresponding indices as they are more diversified. Moreover, stock selection might not have been that prudent enough in some cases. On an average, the category returns of banking sector funds have been a negative 30 per cent in six months, while the BSE-Bankex fell by around 16 per cent during the same period. In the case of technology-based funds, the category average was a negative return of almost 42 per cent, while BSE-TEC and BSE-IT had fallen 33 per cent and 34 per cent, respectively. The funds investing largely in the FMCG space have on an average given negative returns of more than 27 per cent, while the BSE-FMCG index has fallen by 13 per cent. The category average return of auto funds has been a negative 35 per cent, while the BSE-Auto has fallen by 33 per cent. The only sector-based funds that seemed to have outperformed their index counterparts are pharma funds, with category average returns of around negative 24 per cent, while the BSE-Healthcare index fell by more than 30 per cent.

In the long run…Index Funds prevail

In India, we have index funds that track either the S&P CNX Nifty or the BSE Sensex. Both are large cap indices and therefore, by default, the index funds tracking them are ‘large cap’ funds. Investors, looking to invest in quality stocks across the leading sectors, can take a medium to long-term view and patiently ride through the market gyrations by investing in index funds. Actively managed funds may do better than indices for a short while, but in the long run, the indices will overpower them. Fortunately, the study of long-term investment performance is not one of those areas where one has to go by anecdotes or opinions. It is a field uniquely suited to hard numbers, the harder the better. And here are some of the hardest one can find about this matter. There are 60 actively managed diversified equity mutual funds in India that have existed for five years or more. If one were to add the Sensex and the Nifty to these 60 and rank the resulting list for five-year investment performance, one will find that the Sensex is ranked 50 out of 62 and the Nifty 58 out of 62. It is true that if you take a shorter period, say, one year, you will find the Sensex and the Nifty doing better with the Sensex ranked at 101 out of 169 and the Nifty 87 out of 163 but that is better only compared to their longer-term performance.

No matter how detailed a look one takes at the numbers, the truth is that there are odd periods when the indices do better but most of the time, most active funds beat them handily. This is actually the opposite of what indexing fans would have one believe. However, one is by no means wedded to the idea of active management. In fact, one happens to think that fund management standards in India are declining and eventually, the indices will start doing better than the average (but not the better) funds. But when that day comes, there will not be any need for debates and opinions, hard numbers will prove it beyond doubt.