The Hindu Business Line : New Fund Offers

Quick deployment of assets and a freer hand in fund management could explain the strong performance of new funds. No single theme has, however, emerged a winner in the bull market over the past year.

HAVE you heard this warning: `Volatile market ahead!' or `Mutual Funds are subject to market risks!'? Domestic investors do not appear to think much of them, going by the collections reported by the new fund offers (NFOs), which are showing a rising trend.

While the heightened domestic interest in equities is a positive, the preference for new funds over established ones is disturbing. That several new funds have made it to the top of the performance charts over the past year has only increased investor appetite for NFOs. What explains their good performance? Is it a superior theme, or merely the outcome of a strong bull market? We take a look at the themes that have captured market fancy over the past two years, the performance of NFOs and offer some pointers for investing in fund offers.

Slice and dice the market

Fund-houses have not been strapped for themes to play in the three-year bull rally. These range from infrastructure and service sector funds to fancier "Leadership", "Global Opportunities", "Multicap" and "Lifestyle".

Except for the occasional pharma or auto sector fund, most fund-houses have steered clear of focussing on one sector, as such schemes tend to languish when the theme concerned goes out of favour. Instead, most new funds focus on a group of sectors. So, "infrastructure" funds invest in construction, power, cement, select capital goods stocks and even banks, while "lifestyle" look at all sectors that benefit from rising household spending — from FMCG and consumer durables to tourism and retailing.

No sooner one theme hits the market than scores of similar funds follow. Even being contrarian has become fashionable, with three contra funds launched over the past six months. HDFC Core and Satellite, which invests in a blend of stable, large-cap, core stocks and higher-risk, higher-return, satellite stocks, is among the more unique funds in the market. Magnum Comma, which invests in the stocks of commodity companies, is another.

New versus flagship funds

The variety of funds has, however, caught the imagination of investors. Such has been the overwhelming response to new offers, that several new funds — Franklin Flexicap, SBI Mutual's Magnum Multicap, PruICICI's Infrastructure and Discovery funds, for instance — now have a larger asset base than the most popular or their flagship funds. So much so, that Franklin Templeton Mutual now has Franklin Flexicap as its flagship fund instead of Franklin Bluechip.

With their strong contribution to the total assets under management (AUM), new funds command a significant status across fund houses and their ability to deliver sustained performance is vital for increasing the overall AUMs.

Launched in a raging bull market, most new funds have delivered a good performance, easily outperforming the benchmark indices. Quite a few figure among the top 20 performers, along with other established funds. Some, such as Franklin Flexicap, Kotak Opportunities, DSP ML TIGER, Magnum Emerging Businesses, ING Vysya Domestic Opportunities, PruICICI Discovery and Sundaram India Leadership have even bettered the performance of flagship funds.

The reasons for this vary from a strong theme in DSP ML TIGER to a more focussed approach to investing, as in ING Vysya Domestic Opportunities and Sundaram India Leadership. In Franklin Flexicap, the higher degree of flexibility, as against the stringent norms followed by Bluechip and Franklin Prima, has paid off.

Rapid deployment of funds

Established funds are, usually better placed to reap the benefits of a rising market compared to new ones that take time to build their portfolios. Recently-launched funds have, however, managed to keep pace with established ones by rapidly deploying resources raised from initial offers. While they have a window of six months to deploy their cash, several new diversified funds were fully invested in three.

Even funds that mobilised about Rs 2,000 crore, such as Franklin Flexicap and Magnum Multicap, had invested nearly 80 per cent in the first month after launch. Theme funds, such as Reliance Diversified Power and Tata Infrastructure Fund, however, took relatively less time to invest their assets.

In-built flexibility

Some of the new funds have also given managers a freer hand than what they were accustomed to with typical diversified funds, which could partly explain the superior performance of certain new funds. "Multicap" funds, by far the most popular among new fund themes, allow fund managers to invest across market capitalisation. Such funds promise to be on the right side of the market, switching between mid- and large-caps, as the trends change. Some of the more recent mid-cap funds have the mandate to invest up to 35 per cent in "other than mid-cap stocks", to counter liquidity problems associated with a burgeoning asset base.

While "leadership" funds would normally imply a portfolio packed with frontline companies, funds such as Sundaram Leadership invest a part of their assets in "potential leaders". JM Emerging Leadership Fund has it all. It is a multi-cap fund that invests in stocks that have the potential to become leaders either domestically or globally.

This flexibility appears to provide a margin of safety for funds. It has also been well-received by investors. Funds sporting a "Multicap" or "Infrastructure" theme have raked in the most during their offer period.

Themes that outperformed

But no single theme has emerged a winner in the recent rally. With large-caps leading the rally over the past nine months, newly-launched mid-cap funds were under-performers. So also were "dividend yield" value funds, due to their defensive investment strategy. The exception was PruICICI Discovery, which has been a top performer, thanks to its low weightage of the petroleum sector. Good performance of a theme fund also could not be entirely attributed to the theme. For instance, Magnum Emerging Businesses, a top performer that capitalises on export competitiveness is also heavily weighted on mid-cap stocks. Its performance in recent months has, consequently, witnessed a slowdown, suggesting that the mid-cap bias also played a key role in its superior performance.

Broadly, the performance of "multi-cap" and "leadership" funds has been better, as much because of their focus on large-cap stocks as it was due to their theme. Even here, Franklin Flexicap and ABN Amro Opportunities were the only multi-cap funds that beat the Sensex significantly over the past nine months, while HDFC Premier Multi-Cap and Chola Multi Cap were the laggards.

Track Record

We maintain that funds with an established track record across market phases offer a better investment option. We have recommended investments in Franklin Smaller Companies Fund, and HDFC Core and Satellite due to their unique investment strategy and, recently, in PruICICI Discovery for its sustained strong performance.

If you are willing to take the risk of investing in new funds, be selective. Avoid investing in themes in which you already have exposure. If you find a gap in your investment portfolio, look for funds operating in that space, before considering a new fund. For instance, most theme funds now invest in several sectors, not too different from diversified funds that take a focused exposure to sectors in fancy, such as DSP ML Opportunities.

If a new fund has a unique theme to offer and you are comfortable with its risk profile, invest in it after you have had a chance to evaluate its performance and check out how strictly it sticks to its mandate. Avoid using the NFO route to increase your exposure to mutual funds. Investing in a series of NFOs (new fund offers) could saddle you with an unwieldy portfolio.

If you have invested in an NFO, give the fund a chance to perform. A good fund or theme may underperform for a brief period due to difficult market conditions, as has been the case with a few of the value funds. If a fund dramatically trails the benchmark index for several months, then switch to a well-established fund. Evaluate its performance a year on and hold on if the performance has been impressive.

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