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S. Vaidya Nathan

FRANKLIN Prima, HDFC Equity, HDFC TaxSaver, SBI Magnum Contra and Reliance Growth have been star performers in the bull market since April 2003; they also have an impressive five-year track record. These funds have performed consistently across quarters and handled different market phases dexterously. Even in our shortlist of preferred equity funds, they figure at the top. Investors can take exposure in these funds using a systematic investment plan, as collectively they constitute an excellent fund basket.

How have they handled the long bull market that has lasted for close to 30 months now, interspersed with a sharp corrective phase last May, and a few periods of sideways price movement? During this period, these five funds owned 125-150 stocks.

We looked at the portfolios of these five-star performers over a three-year period to identify the strategies that paid off handsomely for the fund managers as well as investors.

Tilt towards mid-cap stocks: An early entry into mid-cap stocks has been the common feature; the only exception is HDFC Equity, which essentially has a large-cap focus, and is the top performer in this space. Interestingly, when the bull market got going, HDFC TaxSaver, SBI Magnum Contra and Reliance Growth had a large-cap tilt.

These funds quickly changed tack and loaded their portfolios with mid-cap stocks, though the yardstick now in use will classify such stocks as small-cap. This is a reflection of the breadth and depth of the bull market rally.

Several mid-cap stocks picked by these funds then have graduated to large-cap status, a pointer to the quality of stock selection.

Focus on few ideas: What is interesting is that the fund managers have not embarked on an exercise to identify a large number of investment themes that can deliver value. The thrust has been on identifying a small number of ideas with promise. The mid-cap stocks became, and still are, central to the investment strategy. This meant that these funds acquired larger holdings in mid-cap companies than in large-cap stocks.

This strategy does enhance risks considerably but this has not deterred them from focussing on a few ideas. In an interview to Business Line earlier this year, Mr Sandip Sabharwal, fund manager for Magnum Contra and several other equity funds from the SBI mutual stable, had indicated that six good ideas in a year should be enough to pack a punch.

A show of faith: The strategy of focusing on a few ideas would not have worked had the fund managers not retained faith in the chosen ones or had they shuffled among a few ideas every three or six months. Had these funds moved in and out of stocks at frequent intervals, they would have missed out on much of the price gains.

Allocation to a few stocks may have risen or declined due to profit-taking, but most stocks have remained in the portfolio, indicating the longer-term view of the fund managers. This is one reason why there have not been many changes in the stocks owned by these funds through the bull market.

For instance, Prima retained Indian Rayon, Goodlass Nerolac, Great Eastern Shipping, IPCA Labs, Gujarat Gas, MICO, Ashok Leyland, UTI Bank, Raymond and LIC Housing Finance through the protracted bull market and these remain among its core holdings even now. These stocks, too, have graduated from mid- to large-cap status. It is when stocks make such a transformation that the biggest percentage gains are made, and this is reflected in Prima's numbers.

Even Reliance Growth, the most aggressive of the five and seen as a momentum-driven fund, has stayed with a core group of about 25 stocks; it has also held a trading portfolio accounting for about 10 per cent of assets.

Picking unfashionable stocks: What also stands out is the ability of these funds to back stock ideas that were hardly fancied when they picked up stakes. Amtek Auto, Ucal Fuel, Shanthi Gears, Indo Rama Synthetics, Crompton Greaves, Carborundum Universal, Praj Industries, Sintex Industries, KEC International and Jaiprakash Associates were picked by one or more of these funds at a time when these stocks were relatively poorly researched and under-owned by institutional investors. As these stocks attracted several institutional and retail investors, in 2004, these funds reaped manifold gains.

At this stage of the bull market, there are not many ideas in these portfolios that fall in a similar category. This is, however, understandable, as the number of stocks that can deliver bumper return over a one-to-two-year period has dwindled. The focus of these funds now appears to be on protecting and consolidating on the impressive gains made, as the market is expected to offer modest, double-digit returns over the next couple of years.

Deft handling of asset expansion: The asset base of these five funds has risen five-fold during the bull run and they collectively now have about Rs 6,000 crore under management. These funds have handled deftly the rapid scaling up of the asset base, without letting it affect performance. That size can, beyond a stage, prove a problem is clear from the accompanying story. This factor has not affected the investment strategy of a mid-cap tilt, focus on few ideas and backing them over a longer period.

It did help that, barring Prima, the rest had a small asset base when the bull started to run. But even Prima's asset base has doubled and is close to Rs 1,900 crore now. It has remained a superior performer despite its focus on mid-cap stocks; other funds with an asset base in excess of Rs 1,200 crore and a long-term track record essentially have a large-cap focus and it is this aspect that makes Prima such an outstanding story.

Staying compact: Despite a manifold rise in the asset base, the one common attribute of the portfolios of HDFC TaxSaver, HDFC Equity and SBI Magnum Contrais their relatively few stocks. We view this as a big positive, as it reduces the number of correct calls that have to be made in stock selection as well as in timing buy/sell decisions. These funds have retained the compactness of the portfolio without concentrated exposures to a few stocks. This has helped increase the extent to which these funds have outpaced benchmark indices and most diversified funds. These funds are expected to keep their portfolios compact, as HDFC TaxSaver and Magnum Contra still have a modest asset base, and HDFC Equity has a large-cap tilt.

Sectors of choice: Only two sectors — engineering and construction, and auto components — figure prominently and consistently in the portfolio of these funds through the bull market. Otherwise it has been a stock-specific approach all the way. Prominently missing are stocks from the FMCG (fast-moving consumer goods) and pharmaceuticals sectors, barring such exceptions as Marico and Cipla; these funds have also gone light on finance stocks, notable exceptions being State Bank of India and UTI Bank.

Staying light on finance — a star performer in the bull market — has not prevented these funds from delivering stellar returns. This just goes to show that you need not buy into every theme fancied in the market.

Preferred stocks: Across the three-year period, a few stocks consistently enjoyed a high degree of preference in one or more of these funds:

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