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Sunday, Jan 11, 2004

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Funds' risk profile less-than-average

Suresh Krishnamurthy

MARKETS are on a roll and mutual fund equity schemes have delivered significantly better returns compared to indices such as Sensex and Nifty. But what would happen if markets were to reverse direction?

Chances are equity funds would still continue to beat the indices. This is what an analysis of the portfolio beta and portfolio price earnings multiple (PEM) of a sample of prominent equity funds suggests.

Portfolio beta: Beta indicates how a stock has moved relative to that of an index. A beta of 1 indicates that stock moved in line with that of the index. The beta of equity mutual fund schemes was calculated by considering the beta of stocks included in the portfolio. This beta is with reference to stock price movement in 2003.

This analysis, based on the portfolios at the end of November 2003, revealed that the portfolio beta is on an average about 0.9. An average of 0.9 indicates that if the markets suffer a 20 per cent decline, NAVs of equity mutual funds will decline by about 18 per cent. The beta was highest for HDFC Top 200 Fund at about 1.03 and lowest for Prima at about 0.70.

Portfolio PEM: The price to earnings multiple of stocks in the portfolio was considered for calculating the portfolio PEM. The portfolio PEM was on an average about 18.7. This is lower than the PEM of Sensex of about 20.1. Again, the lower PEM of equity funds indicates that funds are likely to outperform indices such as Sensex and Nifty even in a market downturn. The PEM was lowest for Prima at about 16.9 and highest for Sundaram Growth at about 21.7.

Similar profile: The lower levels of Betas and PEMs suggest that at least prominent equity funds will outperform the indices in a market downturn.

This is encouraging to investors. However, the profile of some of the 14 funds considered for the analysis is disconcertingly similar.

The beta of about 12 funds was in the range of between 0.85 and 1.02. If this suggested at least a moderate degree of divergence, then a look at the PEM of the funds would make you change your mind quite quickly. The PEM of 10 out of the 14 funds ranged between 17.5 and 19.9.

The similarity in their profile suggests that in a downturn, the performance of the funds may not be substantially different from each other. If future performance would not be substantially different, then the potential for diversification by investing across such funds is low.

In this context, the only meaningful way to diversify appears to be hold exposures to categories of funds such as Large-cap (Bluechip, HSBC Equity, HDFC Equity, Templeton India Growth), Mid-cap (Prima, HDFC Tax Plan, Reliance Vision) and Diversified (HDFC Top 200).

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