FUND FULCRUM

September 2018

The Indian mutual fund industry showed remarkable resilience in the face of declining currency, increasing oil prices and market volatility by reaching close to the quarter lakh crore mark for the first time, according to AMFI data. While the month end AUM stood at Rs. 25.20 lakh crore, the average for the month was slightly lower at Rs. 24.70 lakh crore. In the last decade, the mutual fund industry has grown by nearly 5 times from Rs. 5.45 lakh crore on August 31, 2008 to Rs. 25.20 lakh crore as on August 31, 2018.  The growth has been more aggressive in the last five years with the industry AUM increasing three fold from Rs. 7.66 lakh crore (on August 31, 2013). In fact, after touching the Rs. 10 lakh crore mark in May 2014, the industry has been beating one milestone after the other. Customer centric regulations by SEBI and AMFI’s initiatives have played a pivotal role in bringing customers from smaller cities into the mutual fund’s fold.

The year 2018 has been a volatile one so far for both equity and debt markets. However, investors seem to be resilient to market vagaries. This is reflected in the steady increase in the number of folios. In the one year period ending August 2018, the industry has added over 1.57 crore folios. In fact, of the total 1.57 crore folios, close to 1.5 crore folios were in equity funds. Equity funds include pure equity funds, ELSS, balanced funds and ETFs. Income funds recorded only a marginal increase in folios (3.55%). Meanwhile, gold ETF (32,823) and gilt funds (28,147) saw a decline in folios. In percentage terms, liquid funds saw the highest increase in folios (48.19%) followed by equity funds (30%). On the other hand, gilt funds recorded a 30% decline in their total folio count. The month of August 2018 saw 10.8 lakh new folios being added. The monthly trend was in line with the annual data.

SIPs have been the preferred route for retail investors to invest in mutual funds as it helps them reduce market timing risk. According to the latest data, SIP contribution in August 2018 was Rs 7,658 crore, a little higher than Rs 7,554 crore seen in the preceding month. In comparison, the industry garnered Rs 5,206 crore in August 2017 and Rs 3,496 crore in August 2016. SIP flows seem to have contributed predominantly to inflow in mutual fund schemes as investors remained wary of expensive valuations amid rising concerns over high oil prices and rupee depreciation. On a year on year basis, SIP flows have grown by 47% compared to last year. 90% of the SIP flows have come in equities. This translates to equity schemes seeing Rs. 6,892 crore of inflows in August 2018 through the SIP route. AMFI data shows that equity funds reported sales of Rs.25,393 crore during the month. This means that, 27% of the equity flows come through the SIP route. So far, the industry has received SIP flows worth Rs. 36,760 crore since April 2018.  At the corresponding period last year, the industry had collected Rs. 23,750 crore. The data also reported that the total mutual fund accounts stood at 2.38 crore at the end of August 2018 rising from 2.33 crore in the previous month. Overall, the industry added about 10.07 lakh SIP accounts on an average each month during the financial year. The average SIP size was Rs. 3,200 per account.

Piquant Parade

Principal Financial Group announced the completion of a full share buyback of Punjab National Bank shares giving the financial group full ownership of their joint venture, Principal PNB Asset Management Company Private Limited. Punjab National Bank had 21.38% stake in Principal PNB AMC. However, Punjab National Bank will continue to distribute the schemes of Principal Mutual Fund through its branch network. Principal has been in India for nearly 20 years, offering investment products and services to retail and institutional clients. As at the end of June 2018, the average assets under management of Principal Mutual Fund stood at Rs 7,418 crore.

Regulatory Rigmarole

Pension fund managers of National Pension Scheme (NPS) cannot invest more than 5% in equity mutual funds from now. Pension Fund Regulatory and Development Authority (PFRDA) has written to pension fund managers asking them to restrict the exposure to 5% of the total portfolio of the fund. This will mean that going forward, each of the securities will have to be reviewed and a blanket investment into an equity mutual fund will not be permissible. Pension fund managers invest into a range of instruments in the equity and debt segment to have a diversified portfolio and offer risk-weighted returns to customers. PFRDA recently allowed NPS customers to invest up to 75% into equity instruments. Pension fund managers are responsible for allocating the money invested by customers into different instruments. Here, instead of looking at securities and choosing between them based on the past performance and future prospects, pension fund managers were investing directing into equity Mutual Funds which relieved the Pension Fund Managers of the responsibility of actively managing the funds and thereby save costs.

The Mutual Fund Advisory Committee (MFAC) has recommended to SEBI that the market regulator should consider introducing performance linked fee structure in the Indian mutual fund industry to rationalize TER. While underperforming schemes will no longer enjoy similar TER as of performing schemes, such schemes cannot attract fresh inflows after three years. The committee has reportedly suggested SEBI that if a scheme underperforms its benchmark by 2% in the first year, fund house will have to reduce TER by 0.25%. Further, such a scheme will have to reduce its TER by another 0.25% in the second year if it continues to underperform its benchmark by 2%. Finally, in the third year of underperformance to the extent of at least 2%, the scheme will have to reduce its TER by 0.50%. Also, such a fund house will have to close subscription for fresh sales on its scheme after three years of underperformance. On the other hand, if a scheme outperforms its benchmark by 5%, fund houses can increase its TER by 0.25%. Performance linked fee is prevalent in a few developed markets. In the most recent examples, two leading global investment houses - Fidelity International and Allianz Global Investors have linked their management fees with the performance of their active schemes. While Fidelity International follows this model for charging fees on its funds sold internationally, Allianz Global charges investors a management fee only if they beat their benchmarks across all active schemes. In fact, a few fund houses such as Orbis Investment Management operate many of their active funds on a ‘no performance no fee’ model; the company refunds cash to investors if their funds underperform their respective benchmarks. Many of these investment houses have been under pressure to justify charges under active funds. In 2005, Sahara Mutual Fund had introduced such a model in India. However, the model did not fare well among investors and distributors. The fund house had segregated the fee structure in two buckets– recurring expenses and management fees. While they did not touch recurring expenses, the management fees varied with the performance. For instance, if the fund delivered positive returns but did not manage to beat its benchmark, the fund house charged half the management fees. Similarly, the fund house charged full management fee if the fund outperformed its benchmark. There were no management fees on negative returns and underperformance.

In a communication with distributors, AMFI has cautioned distributors against using the word ‘mutual fund’ in suffix and prefix of email labels. Simply put, if you are sending an email communication from your email id viren@makeyouwealthy.com, you cannot use ‘Viren Mutual Fund’ as the sender’s name on your email communication. SEBI and AMFI have noticed instances where distributors have communicated with clients through their email IDs by using the word ‘mutual fund’ on sender’s name. AMFI said, “Recently certain instances were brought to the notice of AMFI and SEBI, wherein the mutual fund distributors had adopted email labels suffixed with the words "Mutual Fund" [for example, "ABC Mutual Fund" or  XYZ Mutual Fund" {where ABC & XYZ are  the names of the ARN holders} while sending promotional "no-reply" emailers regarding mutual fund investment.” AMFI has asked distributors not to use such names in their email labels to mislead investors. “While the concerned distributors were advised by AMFI to stop using such names immediately as such email labels could be mistaken to have been sent by a genuine mutual fund by uninformed persons, AMFI's ARN Committee and the Board of Directors of AMFI have expressed concern in this regard, and have advised that mutual fund distributors should refrain from using the term "Mutual Fund" in their email label or in their proprietary names in any manner,” added AMFI. A few months back in April 2018, AMFI had cautioned distributors against tweaking the ‘Mutual Fund Sahi Hai’ (MFSH) campaign line to promote their own business. AMFI has found instances where some distributors and IFA associations have violated SEBI guidelines by using the ‘Mutual Fund Sahi Hai’ logo inappropriately.

SEBI has asked fund houses not to pay upfront commission to mutual fund distributors. In fact, the market regulator has asked fund houses to follow all-trail model to compensate their distributors. The market regulator has clarified that fund houses will have to pay such commissions from the scheme and not from the AMC book. In addition, SEBI has asked fund houses not to do upfronting of any trail commission. However, fund houses can do upfronting of trail commission on SIPs subject to fulfilment of pre-defined conditions. In a press release, SEBI said, “All commission and expenses, etc. shall necessarily be paid from the scheme only and not from the AMC/Associate/Sponsor/Trustee, or any other route. Further, the mutual fund industry must adopt the full trail model of commission in all schemes without payment of any upfront commission or upfronting of any trail commission. A carve out has been provided for upfronting of trail commission in case of SIPs subject to fulfilment of certain conditions.” On TER structure, SEBI has introduced fresh AUM slabs and given a roadmap to fund houses on how they can make changes to their TER based on asset size of the scheme. While the market regulator has capped TER at 2.25% in equity funds and 2% in other than equity funds, SEBI has followed economies of scale to reduce TER systematically. Similarly, fund houses cannot charge more than 1.25% in close end equity funds and 1% in close end debt funds. SEBI has also asked fund houses to charge a maximum TER of 1% on passive funds such as index funds and ETFs. On fund of funds (FOFs), SEBI has said that FOFs investing in liquid, index and ETFs cannot charge over 1%. On the other hand, FOFs investing primarily in actively managed funds can charge up to 2.25% in equity funds and 2% in other than equity funds. SEBI said that the slab wise limits of TER were introduced in 1996 and observed that over time, there have been varying practices in the industry with respect to charging of expenses and payment of commissions. SEBI said, “The Board took note of the benefits of the proposal with respect to sharing of economies of scale, lowering the cost for mutual fund investors, bringing in transparency in appropriation of expenses, and reducing mis-selling and churning.” SEBI has also clarified that the additional expenses of 30 bps for penetration in B30 cities is applicable only if assets come from retail investors. “The additional incentive shall be permitted for inflows from individual investors only and not on inflows from corporates and institutions. Further, the B-30 incentive shall be paid as trail only. The market regulator has also asked fund houses to disclose performance of their schemes against its total return index benchmark on AMFI website.

Over the last few years SEBI has come up with many rules and regulations for making the lives of investors simpler. AMFI is doing its bit too – with the high decibel and highly engaging ‘Mutual Funds Sahi Hai’ and now the ‘Jan Nivesh’ initiative to make mutual funds known to the retail investors that much better.

NFONEST

September 2018

As the equity markets head upwards, new fund offers from mutual funds are on the rise. They attract investors with catchy and thematic advertising, pushed by various fund houses and distributors.

NFOs of various hues adorn the September 2018 NFONEST.

Reliance India Opportunities Fund – Series A

Opens: September 7, 2018

Closes: September 21, 2018

Reliance Mutual Fund has launched a new plan named as Reliance India Opportunities Fund - Series A, a close-ended equity oriented scheme. The scheme will have tenure of 1222 days from the date of allotment of units. The investment objective of the scheme is to provide capital appreciation to the investors, which will be in line with their long term savings goal, by investing in a diversified portfolio of equity and equity related instruments with small exposure to fixed income securities. The plan would invest 100% - 80% of assets in diversified equity and equity related instruments with high risk profile and 20% of assets would be allocated to debt and money market instruments with medium to low risk profile. The performance of the scheme would be benchmarked against S&P BSE 200 Index. The fund managers of the scheme are Sailesh Raj Bhan and Kinjal Desai.

Shriram Multicap Fund

Opens: September 7, 2018

Closes: September 21, 2018

Shriram Mutual Fund has launched a new fund named as Shriram Multicap Fund, an open ended equity scheme investing across large cap, mid cap, small cap stocks. The investment objective of the scheme is to generate long term capital appreciation by investing in an actively managed portfolio predominantly consisting of equity and equity related securities diversified over various sectors. The scheme would allocate 65%-100% of assets in equity and equity related instruments including derivatives with medium to high risk profile and 35% of assets would be allocated to debt and money market instruments with low risk profile. Benchmark Index for the scheme is NIFTY 500 TRI. The fund manager of the scheme is Kartik Soral.

Sundaram Long Term Tax Advantage Fund - Series V

Opens: June 25, 2018

Closes: September 24, 2018

Sundaram Mutual Fund has launched a new fund named as Sundaram Long Term Tax Advantage Fund - Series V, a closed-end equity linked saving scheme with a statutory lock in of 3 years and tax benefit. The tenure of the scheme is 10 years from the date of allotment of units. The investment objective of the scheme is to generate capital appreciation over a period of ten years by investing predominantly in equity and equity-related instruments of companies along with income tax benefit. The scheme will invest 80%-100% in equity and equity related securities with high risk profile and invest up to 20% of assets in fixed income and money market securities with low to medium risk profile. The scheme’s performance will be benchmarked against S&P BSE 500 Index. The fund managers of the scheme are S Krishnakumar and Dwijendra Srivastava.

ICICI Prudential Liquid ETF   

Opens: September 10, 2018

Closes: September 24, 2018

ICICI Prudential Mutual Fund has launched a new fund named as ICICI Prudential Liquid ETF, an open-ended Exchange Traded Fund tracking S&P BSE Liquid Rate Index. The investment objective of the scheme is to invest in CBLOs. The scheme aims to provide returns before expenses that closely correspond to the returns of S&P BSE Liquid Rate Index, subject to tracking errors. The scheme will invest 100% - 95% of its assets in CBLOs and invest up to 5% of assets in units of liquid schemes, money market instruments (with maturity not exceeding 91 days), cash and cash equivalents with low to medium risk profile. Benchmark Index for the scheme is S&P BSE Liquid Rate Index. The fund manager of the scheme is Rohan Maru.

Sundaram Emerging Small Cap Fund Series VII

Opens: September 10, 2018

Closes: September 24, 2018

Sundaram Mutual Fund has launched a new fund named as Sundaram Emerging Small Cap Series VII, a close-ended equity scheme investing predominantly in small cap stocks. The tenure of the scheme is 5 years from the date of allotment of units. The investment objective of the scheme is to seek capital appreciation by investing predominantly in equity/equity-related instruments of companies that can be termed as Small Caps. Small Cap Stocks are defined as 251st company onwards in terms of full market capitalization. The scheme will invest 65%-100% assets in equity and equity related instruments of small cap companies with high risk profile and invest up to 35% assets in fixed income and money market securities with low to medium risk profile. The scheme’s performance will be benchmarked against S&P BSE 250 Small Cap Index. The fund managers of the scheme are S Krishnakumar and Dwijendra Srivastava.

Sundaram Money Market Fund  

Opens: September 12, 2018

Closes: September 26, 2018

Sundaram Mutual Fund has launched a new fund named as Sundaram Money Market Fund, an open ended debt scheme investing in money market instruments having maturity of up to one year. The investment objective of the scheme is to generate income by investing in a portfolio comprising of money market instruments having maturity of up to one year. The scheme would allocate 100% of assets in money market instruments as defined by RBI/SEBI from time to time and cash with low to medium risk profile. Benchmark Index for the scheme is CRISIL Money Market Index. The fund managers of the scheme are Siddharth Chaudhary and Sandeep Agarwal.

BOI AXA Midcap Tax Fund - Series 2

Opens: July 12, 2018

Closes: October 11, 2018

BOI AXA Mutual Fund has launched a new fund named as BOI AXA Midcap Tax Fund - Series 2, a 10 year closed-ended equity linked savings scheme. The scheme seeks to generate capital appreciation over a period of ten years by investing predominantly in equity and equity-related securities of midcap companies along with income tax benefit. The scheme shall invest 65%-100% of assets in midcap equity and equity related securities such as cumulative convertible preference shares and fully convertible debentures and bonds of companies etc. with high risk profile and invest up to 35% of assets in debt and money market instruments with low to medium risk profile. Benchmark Index for the scheme is Nifty Midcap 100 TRI. The fund manager of the scheme is Saurabh Kataria.

 

Sundaram Multi Cap Fund – Series III-V, Tata Dual Advantage Fund - Series 6, Tata Small Cap Fund, IL&FS Infrastructure Debt Fund – Series 4, IIFL US Technology Fund, UTI Gilt Fund – 10 Year Constant Maturity Fund, India Bulls Savings Fund, ICICI Prudential Capital Protection Oriented Fund – Series XIV, SBI ETF Quality Fund, Sundaram Emerging Small Cap – Series VIII – X, Tata Nifty Exchange Traded Fund, Mirae Asset Nifty 50 ETF, Motilal Oswal Nifty 250 Index Fund, BNP Paribas Small Cap Fund, UTI Global Focused Growth Equity Fund, BOI AXA Small Cap Fund, Sundaram Equity Savings Fund, Motilal Oswal NASDAQ 100 Fund of Fund, IDBI Dividend Yield Fund and IDBI Healthcare Fund are expected to be launched in the coming months.

GEMGAZE

September 2018

All the GEMs from the 2017 GEMGAZE save Birla Sunlife Frontline Equity Fund, which performed reasonably well through thick and thin, have been accorded a solemn farewell in the 2018 GEMGAZE. Funds of various hues have been accorded a red carpet welcome.

Birla Sunlife Frontline Equity Fund Gem

Birla Sun Life Frontline Equity Fund, one of the most consistent large cap funds over the last several years, has always been in the top 2 quartiles and it has been in the top quartile in the last 4 years out of 5. The out performance gap versus the benchmark has been fairly stable, which shows prudent risk management. 3 year rolling return of the fund was never negative in the last 10 years; the minimum 3 year rolling returns was 1.2%. The maximum three year rolling returns was 31%. The expense ratio of the fund is 2.25% and turnover is 55%. This fund has generated significant alpha over benchmark and category over a decade. Good performance resulted in assets expanding to over Rs 21,880 crore by August 2018. The fund has a bias for large cap growth oriented stocks. Large cap stocks account for nearly 90% of the portfolio value. In terms of sector allocation, the portfolio has a bias towards cyclical sectors like Banking and Finance, Automobiles, Oil and Gas etc. To balance the exposure to cyclical sectors, the fund also has significant allocations to defensive sectors like Technology, FMCG and Pharmaceuticals which comprise about 23% of the portfolio value. In terms of company concentration the fund is fairly well diversified, the top 5 companies, HDFC Bank, Infosys, ITC, ICICI Bank and Tata Motors, all Sensex heavyweights, account for only 22% of the portfolio value. The fund is well diversified with around 70-80 stocks in the portfolio. Birla Sun Life Frontline Equity Fund has built a strong reputation as a wealth creator for its investors. Steady management team manages the fund with style continuity. This results in low volatility and sustained performance.

HDFC Midcap Opportunities Fund Gem

A silent consistent performer over the years, the Rs. 21,952 crore HDFC Mid-Cap Opportunities Fund, launched over a decade ago, has made its name among consistent performers in the mutual fund arena. This fund is an open ended scheme managed by star fund manager Chirag Setalvad since inception. HDFC Mid-Cap Opportunities Fund earlier had a mandate to invest in a mix of mid-caps and small-cap stocks. However, the aim now will be to predominantly build a portfolio of mid-cap companies that have reasonable growth prospects, sound financial strength, sustainable business models, and acceptable valuation that offer potential for capital appreciation. HDFC Mid-Cap Opportunities Fund follows bottom up approach of stock picking wherein the stocks are bought primarily for the strengths of company fundamentals rather than the strength of the macro-economic indicators. It holds a well-diversified equity portfolio with no more than 10% exposure to any particular sector. None of the holdings have an exposure of over 5% in the portfolio. Out of the 65 stocks in the portfolio, the top 10 holdings command an allocation of 30%. In terms of long-term performance, HDFC Opportunities Fund has generated strong returns in the market rallies of the past and has been able to restrict losses in a bear market. The expense ratio is 2.25% and the turnover ratio is 59%. Had you invested Rs 10,000 in HDFC Mid-Cap Opportunities Fund, five years back in 2013, it would have grown to Rs 33,831 in 2018. This translates in to a compounded annualised growth rate of 27.59%. In comparison, a simultaneous investment of Rs 10,000 in its current benchmark - Nifty Midcap 100 - TRI would now be worth Rs 27,718 (a CAGR of 22.60%). Over the past five years, HDFC Midcap Opportunities Fund has taken a lead over the benchmark right from the very beginning. Through the years it has managed to expand the gap over the benchmark, leading to an attractive alpha at the end of the 5-year period.

ICICI Prudential Bluechip Fund (erstwhile ICICI Prudential Focused Bluechip Fund) Gem

Among mutual fund schemes that have singular focus on large-sized companies, the Rs. 19,836 crore ICICI Prudential Bluechip Fund has distinguished itself by consistently beating its benchmark and peers by a reasonably good margin. The fund has traditionally had a higher-than-category allocation to large caps. Its mandate earlier called for a concentrated portfolio, with the stock picks drawn from the top 200 stocks by market cap. Post SEBI reclassification, the fund is repositioned as a pure large-cap fund. It has tweaked its mandate to maintain a minimum 80% exposure to the top 100 stocks by market cap. This will not materially change its risk or return profile, given that the market-cap range is practically the same. The 'focused' approach has been dropped from the mandate. This is in any case a positive, given that the fund's burgeoning size made a very compact portfolio difficult. The only limitation to assessing this fund is that despite its consistent show in the last nine years, it has not seen a serious bear market since inception. In 2011 and in 2015, it managed to contain downside well relative to the market. Another factor that works in favour of the scheme is the presence of ace fund manager S Naren, who has a strong record of being at the helm of well-performing schemes. He is known to be one of the few fund managers who have been conscious of investing in companies which may be out of favour, but hold promise of visibility of earnings in the long term. In the past three- and five-year periods, the scheme has delivered 13% and 18% returns, while its benchmark, Nifty50 TRI, has given 12% and 16% returns in the same period, respectively. This scheme has beaten both the category and benchmark in eight of the nine years since launch.  The expense ratio is 2.11% and the turnover ratio is 116%. Investors looking to invest in an ‘all-weather’ and ‘true to-its-label’ large cap portfolio can consider investing in this scheme. 

DSP Equity Opportunities Fund (erstwhile DSPBR Equity Opportunities Fund) Gem

A very steady performer in the multi-cap category, this Rs. 5947 crore fund is a flexi-cap fund with no pre-defined market capitalisation limits. However, the fund has had a bias towards large caps. In recent times, the fund has maintained a 70% plus large-cap exposure, with mid-cap stocks at about 20%. It is overweight on large caps relative to the category. The fund does not like to cling to the 'growth' or 'value' styles. Key parameters looked at while identifying an investible stock are the growth potential of the business, confidence on predictability of business variables, return on equity, management quality and stock valuation (relative to the stock's history and peers). The fund contains risks through a maximum portfolio weight of 10% in a stock and has a cap of 7.5% on its cash levels. After a short blip in 2012, this fund has pulled up its socks to deliver significant outperformance in the last five years. Its three- and five-year returns are 6-7 percentage points ahead of the benchmark returns and 3-4 percentage points more than the category returns. Looking back, the performance shows that the fund has contained losses well relative to its benchmark in the bear years of 2008 and 2011. But it has trailed the index in a few bull years such as 2007 and 2012. This could be indicative of its conservative approach to valuations. The expense ratio is 2.2% and the turnover ratio is 80%. With a 10-year return of 12.29%, the fund has outperformed the benchmark index (9.51%) as well as the category average (10.99%). The fund has beaten its benchmark and the category average over the past decade. The scheme has been a consistent outperformer in recent years.

FUND FLAVOUR

September 2018

Diversified Equity Funds

Key to excel amidst volatility

The word diversified means variegated or different. We all have heard the phrase “Strength lies in differences and not in similarities”. The same is conceptualized in the mutual fund industry as “Diversified Equity Funds”. In diversified equity mutual funds your investment is broken down into small segments and then re-invested into diversified categories of listed stocks. As, diversified funds invest across market caps such as – large cap, mid cap and small cap, they master in balancing the portfolio. Diversified Equity Mutual Funds invest in a combination of assets from various sectors e.g. Pharmaceuticals, IT, Banking, Real estate, Oil & Gas, FMCG, Telecom, etc. with the aim of achieving long-term capital appreciation. The mutual fund portfolio focuses on equity investments and is not restricted to a specific sector. This diversified allocation of funds across various sectors ensures that risk is minimized. The heart of diversified equity mutual funds is security. While investing in different categories and diversified schemes of the same category the money invested is secure from the sudden shock that the market gives. By investing in the best diversified equity funds, investors can earn slightly more stable returns. However, they would still be affected by the volatility of equities during a turbulent market condition.

One up on other funds…

·         Diversified equity funds invest across various sectors and market capitalization. Different sectors play out differently in various market cycles. For example – if the markets are rising the largest market cap stocks tend to perform well during the initial phase of the bull market. Mid and small cap stocks also tend to do very well when large cap valuations look stretched. However, when in bear markets, mid cap and small funds tend to be more volatile than large cap funds. Therefore, we can say that while the large cap holdings of the diversified equity fund provides a certain degree of stability in volatile market conditions; the small and midcap holdings enhance the returns over a long investment horizon.

·         Diversified funds are all season funds. As an investor, instead of choosing many funds from different categories you can choose a couple of diversified funds and remain invested for the long term. For example – you can choose funds from large cap, small cap, mid cap and sector funds and create a diversified portfolio. Whereas, if you are choosing good diversified equity funds then you need not select many funds from different categories.

·         Diversified funds can provide superior returns compared to large cap and sector funds over a long investment horizon. The underperformance of one sector or market cap segment gets compensated by good performance of another sector or market cap segment.

·         Diversified fund rebalances the risk. As you are investing across sector/ market and capitalization, your risk also gets rebalanced. For example – you can invest in mid and small cap funds and take much higher risk but if you are investing in diversified equity funds the risk gets mitigated to a greater extent due to the large cap stock holding in the portfolio. While you may take moderate risk investing in large cap funds, in diversified equity funds, though your risk rises to moderately high level (due to mid / small cap holdings), you can be compensated by the superior returns.

In fact, Diversified Equity Funds work well in dynamic market conditions.

…beating them in their terrain

Research shows that in terms of risk return characteristics, diversified equity funds have given superior returns than large cap funds. The annual returns of diversified equity funds as a category have always been superior to large cap funds in most of the last 12 years  – excepting in the year 2006, 2008 and 2011. 2006 was an exceptional year when large cap returns were better than that of diversified equity funds. Year 2008 and 2011 were the years when markets gave negative returns. After the great fall in 2008, the diversified equity funds gave almost 85% return in 2009 when the markets rallied, compared to around 65% return by large cap funds. Similarly, after a subdued performance in 2013 by both the categories, the diversified equity funds again bounced back by giving 50% return compared to around 35% return by large cap category in the year 2014. The trailing returns of diversified equity funds were superior then large cap funds over the last 1, 3, 5 and 10 year periods.

Through the crystal ball…

Well, no one has a magic crystal ball that can foretell which mutual fund schemes will top the list over the next decade. However, through years of experience, one can define a process that can be used to shortlist potentially the best diversified mutual fund schemes for the future. There are various aspects within a mutual fund scheme, which are vital for investors to analyse before investing; which are:

·        Performance: The past performance of a fund is important. But, remember that past performance is not everything, as it may or may not be sustained in future and therefore should not be used as a basis for comparison with other investments. It just indicates the fund’s ability to clock returns across market conditions. And, if the fund has a well-established track record, the likelihood of it performing well in the future is higher than a fund which has not performed well.

Under the performance criteria, we must make a note of the following:
 
   

1.    Comparison: A fund’s performance in isolation does not indicate anything. Hence, it becomes crucial to compare the fund with its benchmark index and its peers, so as to deduce a meaningful inference. Again, one must be careful while selecting the peers for comparison. For instance, it does not make sense comparing the performance of a mid-cap fund to that of a large-cap. Remember: Don’t compare apples with oranges. 

2.    Time period: It is very important that investors have a long-term horizon (of at least 3-5 years) if they wish to invest in equity oriented funds. So, it becomes important for them to evaluate the long-term performance of the funds. However this does not imply that the short term performance should be ignored. Besides, it is equally important to evaluate how a fund has performed over different market cycles (especially during the downturn). During a rally it is easy for a fund to deliver above-average returns; but the true measure of its performance is when it posts higher returns than its benchmark and peers during the downturn. 

3.  Returns: Returns are obviously one of the important parameters that one must look at while evaluating a fund. But remember, although it is one of the most important, it is not the only parameter. Many investors simply invest in a fund because it has given higher returns. Such an approach for making investments is incomplete. In addition to the returns, one also needs to look at the risk parameters, which explain how much risk the fund has undertaken to clock higher returns. 

4.    Risk: To put it simply, risk is a result or outcome which is other than what is / was expected. The outcome, when different from the expected outcome is referred to as a deviation. When we talk about expected outcome, we are referring to the average or what is technically called the mean of the multiple outcomes. Further filtering it, the term risk simply means deviation from average or mean return. Risk is normally measured by Standard Deviation and signifies the degree of risk the fund has exposed its investors to. From an investor’s perspective, evaluating a fund on risk parameters is important because it will help to check whether the fund’s risk profile is in line with their risk profile or not. For example, if two funds have delivered similar returns, then a prudent investor will invest in the fund which has taken less risk i.e. the fund that has a lower SD. 

5.    Risk-adjusted return: This is normally measured by Sharpe Ratio. It signifies how much return a fund has delivered vis-à-vis the risk taken. Higher the Sharpe Ratio better is the fund’s performance. As investors, it is important to know the same because they should choose a fund which has delivered higher risk-adjusted returns. In fact, this ratio tells us whether the high returns of a fund are attributed to good investment decisions, or to higher risk. 

Alpha is a measure of diversified fund’s performance on a risk-adjusted basis. It measures how much the fund has performed in the general market on a risk adjusted basis. A positive alpha of 1 means that the fund has outperformed its benchmark index by 1%, while a negative alpha of -1 would indicate that the fund has produced 1% lower returns than its market benchmark. So, basically, an investor’s strategy should be to buy mutual funds with positive alpha.

Beta measures volatility of a diversified fund compared to its benchmark index. Beta is denoted in positive or negative figures. A beta of 1 signifies that the mutual fund NAV moves in line with the market. A beta of a greater than 1 designates that the mutual fund is riskier than the market, and a beta of less than 1 means that the mutual fund is less risky than the market. So, lower beta is better in a falling market. In a rising market, high beta is better.

6.     Portfolio Concentration:  Ideally, a well-diversified fund should hold no more than 50% of its assets in its top-10 stock holdings. Remember: Make sure your fund does not put all eggs in one basket.

7.      Portfolio Turnover: The portfolio turnover rate refers to the frequency with which stocks are bought and sold in a fund’s portfolio. Higher the turnover rate, higher the volatility. The fund might not be able to compensate the investors adequately for the higher risk taken. Remember: Invest in funds with a low turnover rate if you want lower volatility.

·        Fund Management: The performance of a mutual fund scheme is largely linked to the fund manager and his team. Hence, it is important that the team managing the fund should have considerable experience in dealing with market ups and downs. As mentioned earlier, investors should avoid funds that owe their performance to a ‘star’ fund manager. Therefore, the focus should be on the fund houses that are strong in their systems and processes. Remember: Fund houses should be process-driven and not 'star' fund-manager driven.

·         Costs: If two funds are similar in most contexts, it might not be worth buying a mutual fund scheme which has a high costs associated with it, only for a marginally better performance than the other. Simply put, there is no reason for an AMC to incur higher costs, other than its desire to have higher margins.

The two main costs incurred are:

1.   Expense Ratio: Annual expenses involved in running the mutual fund include administrative costs, management salary, overheads etc.  Expense Ratio is the percentage of assets that go towards these expenses. Every time the fund manager churns his portfolio, he pays a brokerage fee, which is ultimately borne by investors in the form of an expense ratio. Remember: Higher churning not only leads to higher risk, but also higher cost to the investor. Also Direct Plans exclude distribution costs, hence, a cheaper alternative to Regular Plans.

2.      Exit Load: Due to SEBI’s ban on entry loads, investors now have only exit loads to worry about. An exit load is charged to investors when they sell units of a mutual fund within a particular tenure; most funds charge if the units are sold within a year from date of purchase. As exit load is a fraction of the NAV, it eats into your investment value. Remember: Invest in a fund with a low expense ratio and stay invested in it for a longer duration. 

After all, you require mutual fund schemes that stand by you in good times and in bad – meaning, the schemes need to manage the downside of the market well, apart from generating sound returns in a market rally.

…taking steady SIPs

In times of volatility, a SIP would undoubtedly be a prudent route as compared to investing your corpus as a lumpsum. If the markets do not turn out in your favour and your SIP delivers disappointing returns, do not be dismayed. When investing in equity, it is important to keep a long-term investment horizon of three to five years or more, even if you are investing via a SIP. The returns may be a few percentage points lower as compared to a lumpsum investment, but it will still be sufficient to meet your financial goals. It is important to note that there are several benefits of investing via a SIP as a regular form of investment - a hassle-free investment route, deals with market volatility and devoid of behavioural biases. For the long term, equities still remain the best route to create wealth. Hence, when investing in diversified equity funds, adopt the systematic approach to investing.