The Hindu Business Line : Mutual funds over the quarter

A mid-cap tilt in the portfolios and high levels of cash appeared to be the primary reasons for one set of funds under-performing the market. Moreover, the market rally itself was restricted to a limited universe of stocks.

The market bellwether Sensex, now back to the 12,000 levels, may have come a full circle after the May debacle, and yet the broad market does not appear to reflect the earlier exuberance. An analysis of the June-September performance of mutual funds reveals a similar view.

While 40 per cent of the diversified equity funds evaluated by Business Line outperformed the Sensex, about 70 per cent of them beat the S&P CNX Nifty (the Nifty, with a portfolio of 50 stocks under-performed the 30-stock Sensex). Clearly, a number of funds fell just short of the Sensex rally. The average diversified equity fund return of 15.7 per cent proves this.

So, why did one set of funds under-perform during this period? A mid-cap tilt in their portfolios and high levels of cash appeared to be the primary reasons, apart from the fact that the market rally itself was restricted to a limited universe of stocks. Sundaram BNP Paribas Select Midcap, a stellar performer over the past few quarters, lost out by holding close to 30 per cent in cash and equivalents. While the fund made a timely move to cash and contained volatility in the June quarter, its prolonged cautious view on the market led to subdued returns.

Some surprises

The quarter did throw up quite a few surprises, with many funds from the Reliance, Birla and Fidelity houses hogging the limelight. Established players such as Franklin Templeton and HDFC Mutual remained passive. Funds from these houses have, however, shown more consistency over several quarters.

All of Fidelity's equity funds (Fidelity India Special Situations, Fidelity Equity and Fidelity Tax Advantage) outperformed the Sensex and the BSE-500. Investors may adopt a hold strategy on these new funds but watch out for the fund's portfolio, which is disclosed every quarter.

Fidelity's Special Situations Fund, which invests in companies with unusual situations, such as financial turnaround, merger or acquisition, is also a nascent theme among the plethora of thematic funds and needs to be closely watched for its stock picks and the ability to stick to its mandate.

A common feature with most of the funds in the top 25 per cent in terms of returns was their high equity holdings. Funds such as Franklin India Opportunities, PruICICI Taxplan and Reliance Regular Savings held 85-95 per cent in equity throughout the quarter. Further, funds that locked into the rally in the banking and IT sectors and made timely moves also benefited. Birla Sun Life Equity, for instance, increased its stake in banks from 5.5 per cent in June to over 12 per cent in August (see Table for BSE Bankex return).

Well-poised

Established funds in the balanced category proved their stability yet again. With returns of about 16 per cent, funds such as HDFC Prudence and FT India Balanced continue to concentrate on a quality portfolio, both in equity and debt segments. Some of the more aggressive funds in this category — such as Magnum Balanced and Kotak Balance — had a mediocre performance.

A number of balanced funds increased allocation to equity to be classified as an equity-oriented fund for taxation purposes. This led to some of the balanced funds not only enhancing their equity holdings but also making a higher allocation to mid-caps. This translates to increased risk in the category. Funds such as FT India Balanced and HDFC Prudence have, however, stuck to their large-cap orientation. The above two funds, therefore remain good options for investors looking at stability rather than flashy returns.

Surfing on sectors

Having stayed away from the bull rally up to mid-May, the quarter saw banking stocks return in style. With a return of 38.5 per cent, the BSE Bankex emerged as the clear winner among the BSE Indices. Reliance, with a host of successful sector funds, saw its banking sector fund return 38 per cent.

In the IT space, DSPML Technology.com and Birla Sun Life New Millennium rallied past the BSE and NSE IT indices. These funds offer a one-stop-shop for exposure to top stocks in the IT universe. These schemes, like all other sector funds, are suitable only for investors who track the market, time their moves and are convinced about the sector's potential.

PruICICI FMCG came up with a surprise return of 17 per cent, beating counterparts from the Magnum and Franklin fund houses by a mile. This is despite the poor showing by FMCG stocks over the quarter. A look into PruICICI's portfolio revealed that the fund had a much more diversified exposure, with FMCG stocks restricted to 55 per cent. Its peers, on the other hand, with holdings over 70 per cent in the sector, suffered a setback.

The engineering and infrastructure funds had a good quarter, with eight of the 10 beating the BSE Capital Goods index. A hold strategy in funds such as Reliance Diversified Power and DSPML T.I.G.E.R appears a good bet at this stage. Strong order-flow and increased policy and budget support from the Government augur well for earnings growth of companies in this space.

Keep watch

A number of new funds launched in 2006 have delivered good returns. DBS Chola Contra, Franklin India Smaller Companies and Kotak Lifestyle all beat the bellwether index. New funds in the close-ended category delivered less impressive returns of about 12 per cent. Derivative-based funds from Reliance and Tata too fell in the same category, as they stayed in cash for a significant period since launch. As they have now moved into the active investing mode, investors need to monitor the funds' ability to hedge risks during volatility.

With the latest guidelines on overseas investing from SEBI offering more clarity, the two global funds, Principal Global Opportunities and Templeton India Equity Income, have turned proactive in their global investment strategy. While the former fared poorly, fettered by a restricted universe of stocks, the latter chose to wait. Principal has now chosen PGIF Emerging Markets Fund as an investment vehicle to route its foreign investments.

Franklin recently invested in stocks of emerging markets such as Thailand, Mexico and Brazil. While the last quarter's performance may not reflect these changes, investors need to watch if the fund's choice of markets is in line with their risk and return appetite.

Credible show

Risk-averse investors can rest assured that there were no alarming signs from the debt category. Floating rate funds have again proved to be one of the more stable investment options within this category. CRISIL Liquid Fund Index, with a return of 1.4 per cent over the quarter, has shown consistency over the past two quarters. Investors who prefer to remain relatively insulated from the changing interest rate regime may find these funds a good option.

The periodic re-adjustment in the floating rate coupon, in tune with the prevailing market rates, makes the product less volatile than income funds. Over 93 per cent of the funds analysed in the category beat the CRISIL Liquid Fund Index. The sharp rally in bonds saw the CRISIL Composite Bond Index return 1.7 per cent, as against 0.9 per cent in the June quarter.

About 55 per cent of the bond funds analysed by us beat this index. PruICICI Income Plan, the topper in the category with a return of about 3.4 per cent, had an average portfolio maturity of four years compared to the less impressive Reliance Medium Term, with average maturity of 0.7 years.

Investors who stayed with our preferred picks, such as HDFC Top 200, DSPML Opportunities or Magnum Contra, may have no reason to worry. A study of the portfolios and investment pattern of these funds suggests they are on the right track. We maintain that an investment decision based on evaluation of several quarters of performance is the preferred way to build wealth.

With the SEBI guidelines paving the way for new products (such as real estate and global funds), investors looking to diversify their portfolios can consider such nascent ideas/themes provided they are willing to track the same actively.

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