The Hindu Business Line : Outpacing the market

A shift to large-cap stocks, focussed investment in sectors that captured growth themes in the economy, and well-timed shifts between sectors enabled the funds tame the volatility witnessed in the quarter.

As the market scales new highs in the first quarter of 2006, mutual fund investors may well wonder if the funds kept up pace. They can rest easy, for not only did they keep pace, a good number of them outperformed the market. This is reflected in the average return of 19 per cent by diversified equity funds in the three-month period compared to the Sensex's return of 16.5 per cent. About 65 per cent of the diversified funds evaluated by Business Line outperformed the Sensex. But none of the sectors and theme funds managed to beat the respective sector indices. However, each recorded impressive returns.

A shift towards large-cap stocks, focussed investment in sectors that captured growth themes in the economy, and well-timed shifts between sectors enabled the funds tame the volatility witnessed in the quarter.

RACING AHEAD

Funds from the SBI Mutual stable once again dominated the leaders' list with three diversified funds appearing among the top ten. Evidently, the group has built up enough momentum to shake off the departure of Mr Sandip Sabharwal, a key fund manager.

While Franklin Templeton and Tata funds delivered reasonable returns, both in the diversified and sector categories, HDFC Mutual Fund had a relatively subdued quarter.

The quarterly performance figures however throw up a few surprises. Funds that appeared in the top quartile of mutual fund rankings were an interesting mix of established schemes and relatively new ones.

With Tata Select Equity, Magnum Global and Pru ICICI Power, which boast of a five-year track record, in the list of top performers, are a clutch of relatively new funds such as Kotak Mid-Cap, Reliance Equity Opportunities and Sundaram India Leadership, all about a year and half old.

These funds have capitalised on themes that found favour with the investor community during the current bull run in the market. While existing investors can hold on to these schemes, fresh exposures can wait.

Our list of top ten equity funds is dominated by funds with an asset base of less than Rs 500 crore. The compact asset base has aided funds make focussed bets.

EXPANDING ASSET BASE

However, there are larger funds that have sustained good performance. Funds with a long track record such as Franklin India Bluechip and HDFC Equity have shown consistent performance with an asset base that has now crossed Rs 2,000 crore. A large-cap tilt and spotting new investment ideas have ensured steady returns for these funds.

Franklin India Prima has graduated to a size of over Rs 2,400 crore. Though the numbers for the latest quarter point to underperformance, we are sanguine about the fund's long-term performance.

Since 2005 the fund has diversified its portfolio to hold 50-60 stocks to mitigate the risks of low liquidity associated with mid-cap stocks. We expect this strategy to keep risks at bay and deliver consistent returns.

A striking feature is the quantum of money new offers have garnered. The recent set of new funds such as HSBC Advantage India and HDFC Long Term Equity has made a start with assets of over Rs 1,000 crore each.

Reliance Equity made history by mopping up more than Rs 5,700 crore through the NFO. While the recent performance trend indicates that fund managers are keen on making a promising start to the new funds in their stable, going forward the mammoth size of the funds can pose a challenge to fund houses to meet investor expectations.

GOOD SHOW, BUT WAIT...

The engineering and construction boom appears to have caught the fancy of fund houses as well. Stocks such as Siemens, Crompton Greaves and Nagarjuna Construction were seen in many a portfolio of diversified funds that appeared in the top quartile of our rankings. The run-up in such stocks has not prompted contrarian funds such as Magnum Contra to exit, as they appear to have taken the view that their potential to deliver returns still appears strong.

A few of the new theme funds in this space, such as Sundaram Capex Opportunities, Tata Infrastructure, Can Infrastructure and Pru ICICI Infrastructure, have delivered returns in the 25-35 per cent range, superior to even many performing diversified funds in our list. While the focused approach of investing in leading sector themes has paid off well in the short term, the performance of such funds require evaluation over a longer time frame before fresh exposures can be had.

Riding well on sector themes are the funds from the Franklin Templeton house. FMCG and pharma schemes from the fund house have captured attention for delivering reasonable returns. Hindustan Lever, ITC and Marico are some of the compelling stocks that appeared in many FMCG portfolios. For the Magnum FMCG fund, it is yet another quarter of missed opportunity as the fund's performance paled in comparison to Franklin or Pru ICICI FMCG.

Major acquisition plans by companies in the healthcare sector has resulted in renewed buying interest in pharma stocks. Tata Life Sciences and Tech, with an interesting combination of technology and healthcare stocks, has not only returned well over the quarter but built a reasonable track record.

Theme funds such as infrastructure, power or FMCG are likely to benefit from the domestic opportunities in the next couple of years. However, any downturn or slowdown in these sectors may affect the fund performance. Investors should make theme funds a small part of their portfolio. Many of the well-established diversified funds capitalise on new ideas and themes and are likely to deliver more consistent if not exceptional returns.

MID-CAPS INSPIRE CONFIDENCE

While mid-cap stocks have been lagging behind the large-cap stocks for the past couple of quarters, the gap between the mid-cap and benchmark indices has narrowed in the current quarter due to improved performance. This was also reflected in the performance of a number of mid-cap funds that managed to outperform their respective indices. In the Pru ICICI basket, while Emerging S.T.A.R has once again showcased stylish performance, Discovery was a laggard. The two funds, however, remain our dark horse picks.

BALANCING ACT

Balanced funds appeared to have done a neat job of drawing from the surge in equity markets and containing volatility through investment in debt instruments. CanbalanceII, Tata Balanced and Kotak Balance notched returns of over 20 per cent. Investors with less appetite for risk and keen to protect capital can consider balanced funds as an option.

LESS IMPRESSIVE

Funds focussed on energy and banking once again floated to the bottom of the fund rankings. Investors may, however, consider holding banking funds such as Reliance Banking and UTI Banking, as stocks in this sector appear attractively valued after the correction in 2005.

A spate of multi-cap funds such as HDFC Premier Multi-Cap and Magnum Multicap that appear to have flexibility to invest across market capitalisation segments have just about kept pace with the market. Whether the flexibility would be put to good use is yet to be tested as a good number of them have a track record of a year or less.

PREFERRED PLAYS

Mutual fund investors can consider using the systematic investment route which gives an opportunity to review the fund performance before locking further investments in a scheme. We continue to be positive on our preferred picks — HDFC Equity, HDFC Top 200 and Magnum Contra — and re-emphasise the `wait-and-enter' strategy for new funds.

Investors need not be concerned about the subdued quarterly performance of our preferred tax plan picks — HDFC TaxSaver, HDFC Long Term Advantage and Pru ICICI Tax Plan. These funds have notched a track record and the lock-in of three years provides scope for improving performance.

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