The Hindu Business Line : Equity fund performance: Absolute returns may be misleading

MENTION UTI Mastergrowth and it is quite likely you will not recall the scheme being part of any list of top performing equity funds. Yet, in terms of risk-adjusted returns, UTI Mastergrowth is up there with the best in the business. You may have ignored the scheme simply because it did not top the charts.

The average monthly returns of UTI Mastergrowth are better than that of BSE-200. The fluctuation in its monthly returns too is lower than that of BSE-200.

What is more, the performance is no flash in the pan. It has outperformed BSE-200 in 27 of the 45 months between January 2001 and September 2004. That is not all. It has accumulated wealth steadily and with lower monthly losses than the index.

Consider HDFC Equity, by contrast. An investor in HDFC Equity in January 2001 would have built more wealth than his counterpart in UTI Mastergrowth.

The scheme has outperformed BSE-200 in 32 of the past 45 months — a better record than that of UTI Mastergrowth. Yet, some investors may be peeved.

This is because in about three of the 45 months the losses were greater than that of the index. It appears that the wealth-building process in HDFC Equity has been rocked by shocks a few times.

You may still prefer to stick to HDFC Equity considering its exceptional performance most of the time. The larger point, however, is that only looking at the absolute returns could be misleading.

Absolute returns will tell you that selection of equity funds is not that important. This is because nine out of ten funds outperform Nifty while four out of five outperform BSE-200.

However, an analysis of monthly returns indicates that in most funds, timing the entry was important and, therefore, selection of equity funds is indeed essential.

Adjusting returns to the fluctuation in monthly returns too may not be enough — again, four out of five schemes do well even on a risk-adjusted basis. What you need is consistency of performance with reference to a benchmark — usually a stock index.

To find out how funds stack up on the parameter of consistent out-performance, the performance of 52 schemes between January 2001 and September 2004 was analysed.

Tracking the returns

For the analysis, the scheme's monthly returns were compared to those of BSE-200.

The BSE-200 was preferred to the Nifty as the former explained the returns of the equity funds better than Nifty.

Barring one scheme, the returns from all schemes moved more in line with that of BSE-200 than that of Nifty. The risk involved in nine of the schemes was higher than that of the market for the period under reference.

The monthly returns of equity funds was subjected to the following parameters:

Higher average monthly returns than BSE-200: Most schemes managed to get past this hurdle. Indian mutual funds have had the knack of doing significantly better than the index when stock prices rise

Higher risk-adjusted returns than BSE-200: Again, most schemes did well. This is because the analysis was done for a period in which BSE-200 had risen 68 per cent. When stock prices rise, they do much better than a portfolio of stocks (index) which has both high-fliers and laggards.

Analysis for any period in which the BSE-200 is in positive territory will show up equity schemes in a favourable light.

Analysis of risk-adjusted returns in April 2003, prior to the bull-run, indicated that several equity schemes had poor records in a bear market.

Outperforming BSE-200 in more than 21 months: This is because the Nifty Index itself outperformed BSE-200 in 21 of the 45 months between January 2001 and September 2004. Thirty-one of the 52 schemes passed these three hurdles. The last two parameters proved a lot more difficult.

Lower monthly losses than that of BSE-200 during market downturns

Lower level of under-performance in the months in which they under-perform BSE-200. Subjected to the last two parameters, the number of outperforming schemes dwindled to 11 from 33. The other 22 schemes, which did not pass the last two tests, clearly offered less downside protection to its investors.

Toppers and trailers

The top performing schemes among these 11 were SBI Magnum Contra, Reliance Growth, HDFC Top 200, Templeton India Growth, Franklin India Bluechip, GIC Fortune and Tata Select Equity.

These schemes notched up higher average returns and at the same time reduced the fluctuations in monthly returns.

Schemes such as UTI Mastergrowth, UTI Grandmaster, UTI Masterplus and Tata Pure Equity also toned down the fluctuations in monthly returns. These schemes, however, recorded lower returns than those mentioned above.

Incidentally, the risk involved in all the 11 schemes has been almost as high as that of the market. They have delivered returns that more than compensate the risk involved. In these schemes, timing your entry has not been as important as it has been in other equity schemes — the reason why these are considered top performers.

The performance of schemes such as SBI Magnum Contra, GIC Fortune and Tata Select equity is particularly revealing. As of now, these schemes lack investor support and assets under management are less than Rs 100 crore.

Schemes such as DSP ML Opportunities, Reliance Vision and Prudential ICICI Power also did well on all parameters excepting one — these schemes lost as heavily or worse in months in which BSE-200 lost value.

Schemes such as HDFC Equity, Alliance Basic Industries and Franklin India Prima also did well in most months, though they have had to contend with performance shocks in a few months.

If you do not consider this performance shock, that is lower downside protection, too important, then these schemes should rank among the best.

Prominent schemes that lagged the index in terms of average returns include Morgan Stanley Growth, Birla Advantage, Principal Equity and UTI Primary Equity.

These schemes did better in terms of risk-adjusted returns. Their performance, however, did not stand up to greater scrutiny.

These schemes outperformed BSE-200 in 23 months or less.

In a few months, Birla Advantage and Principal Equity also sported larger losses than that of BSE-200. This apart, the performance of a number of schemes such as Canbonus, Canglobal, SBI Magnum Multiplier Plus, GIC Growth Plus II Taurus Discovery Stock and ING Vysya Select Stocks were particularly disappointing.

Timing entry

Are the last two parameters, which reduce the list of outperformers significantly, necessary? They are, in rating the performance of equity funds. They are, however, less important in the case of funds which have a record of consistent outperformance.

For instance, consider the schemes of HDFC Equity and Franklin India Prima, both top performing schemes. Had you entered HDFC Equity at the end of November 2003, you would have earned returns of about 18 per cent.

This was much below that of many of its peers as the scheme underperformed BSE-200 significantly in December 2003. In this context, the last two parameters cannot be considered excessively stringent.

On the other hand, consider Franklin India Prima. This scheme underperformed BSE-200 significantly in August 2003. Still, had you invested in July 2003 and stayed invested, you would have still outperformed many of its peers and the BSE-200 handsomely.

Thus consistent outperformance could overcome the effect of the shocks and this can be relaxed in funds with such a record. In funds with average performance records, this measure cannot be relaxed. You may be risking your money then.

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