The Hindu Business Line : Review of five-year performance: Equity funds for all seasons

If you are among those investors who have held on patiently to some of the equity funds with a ‘long track record’ but are beginning to doubt your decision due to their recent performance, fear not. Old favourites such as HDFC Equity Fund or Magnum Contra Fund may not be making an appearance in recent quarterly or even yearly toppers’ charts. But they continue to deliver good performance, often beating their benchmarks. A few funds launched in the last co uple of years have climbed to the top of the rankings by virtue of their high absolute numbers. So which among the established funds have sustained their performance record? Should investors replace some old funds with newer ones in their core portfolio? Here, we run the set of diversified equity funds with a five-year track record through several filters, to shortlist the most consistent performers for an investor’s core portfolio.

The analysis showed that only 7 of the 64 diversified equity funds (including tax planning funds) have repeatedly beaten their benchmarks in each of the last five years (August 2002-2007). A further 28 funds (roughly four out of every 10) have outperformed their benchmark in four of the past five years.

Instead of looking at point-to-point returns over the entire five-year window, performance was divided into yearly intervals and also evaluated on monthly rolling returns, to judge consistency in outperforming benchmarks. While the first requirement from any fund is to beat its benchmark, the next is how well its absolute performance compares with peers.

Measuring consistency

For this, we looked at the ability of each fund to consistently appear in the top quartile of the performance charts every year, over the past five years. This would not only give a fair indication of how well the fund’s strategy has worked but ultimately reflect on the relative skills of its manager.

While the last five years have predominantly witnessed a bull rally, 2006 and 2007 were fairly testing times for equity funds, with intermittent reversals, churn in sector, and stock-specific themes leading the run amidst volatile spells.

Though the evaluation was over a five-year period, greater weight was assigned to recent returns (over the last two years), to see how the funds weathered the challenging market conditions. Theme and sector funds were left out of our analysis as their very nature calls for careful timing of investments to yield high returns; they may not suit buy-and hold investors.

Point to point returns: Not truly representative

Most performance rankings available to investors today would throw up funds such as Magnum Taxgain and Sundaram BNP Paribas Select Midcap as the top performers in the five-year charts, with an annualised return of about 60 per cent each. However, on a point-to-point basis, the returns may not truly represent the fund’s intermittent ups and downs.

Underperformance during difficult market phases may be compensated by high returns during a market rally. While this is good news for an investor holding the fund over a long period, it may provide no clues on how those who entered the fund in different periods fared. Nor would it warn investors of waning performance.

For instance, the impressive five-year returns on the Sundaram BNP Select Midcap Fund mask a slowdown in recent performance. This may not be quickly discernible to an investor who looks only at the five-year annualised return.

Outperformers in each of the five years

The analysis of funds based on whether they beat their benchmark in each of the past 5 years, threw up seven such funds (see Table ‘consistent winners’). Among those, funds such as Franklin India Prima Plus and Sundaram BNP Paribas Select Focus, do not figure in the top quartile based on a point to point five-year return. Yet, they have consistently beaten their respective benchmarks each year. Others such as Franklin India Prima or Taurus Starshare, which figure among the top five-year performers based on aggregate returns, have not beaten their benchmarks in some of the five years.

As to recent performance, as the Sensex has proved to be the toughest benchmark over the last two years (outperforming all other broad indices), the seven funds were compared with the Sensex as well over August 2005-07. Only HDFC Equity Fund emerged a winner.

The fund was among the few to quickly spot the slowing rally in mid-caps by 2005 and made a quick shift to large-caps, thus managing to out-perform the broad markets. Only DWS Alpha Equity and HDFC Top 200 achieved a similar performance among other diversified funds in the last two years. But they failed to meet our five-year criteria of beating respective benchmarks.

Evening out the timing effect

With the markets exhibiting higher day-to-day volatility, it has become imperative to know what returns funds delivered for investors entering at different points in time. A one-year rolling return on an equity fund, calculated at monthly intervals, captures performance across different time periods and provides a better understanding of the fund’s capability to perform through various market phases.

Our analysis of the 64 funds over 60 months suggests that 23 outperformed their respective benchmarks in at least 36 months (out of 60) or about 60 per cent of the time. Apart from the funds mentioned in the Table (‘Those left standing’), funds such as Kotak-30, HDFC TaxSaver and Magnum Multiplier Plus also figure in the list. Some of the old favourites, such as Franklin India Bluechip and HDFC Capital Builder, did not fare too well in this test. Here again, the last two years’ analysis reveals that HDFC Equity has beaten its benchmark 71 per cent of the time, followed by Franklin India Prima Plus, Birla Sunlife Equity and HDFC Top 200.

Old-timers still strong

As investors, you may wish to always see your funds figure among the top few in the performance chart. Unfortunately, the long-term out-performers have struggled on this count. Inability of funds to consistently maintain top quartile rankings is a sober reminder of the risks of chasing past performance.

Barring a few such as Magnum Contra, Magnum Multiplier Plus and Reliance Vision (which appeared in four of the last five years’ top quartile rankings), most funds show a tendency to slip to the second quartile after hitting the top quartile in their first year. In recent years, the larger equity funds lost their top places to younger peers such as the flexi-caps and the go-anywhere opportunity funds.

These funds, also launched by the same fund-houses that manage the older schemes, appear to be much more actively managed, or so it may seem, given the kind of pressure funds are under to prove performance over a short time. However, it is encouraging that in the last two years (which saw a number of funds being launched), 50 per cent (on an average) of the funds that appeared in the top quartile ranking were schemes that had a five-year track record. So, while new funds still jostle for space among the chart-busters, the fittest of the old continue to retain their space.

Core portfolio

This analysis reveals that consistent funds are the ones that should find a place in the core of your portfolio. The upcoming stars could be handy to perk up your returns. The consistency displayed by the older funds funds means that timing your entry or exit does not really matter with them. With a good number of newer funds, given the current market scene, timing may increasingly play an important role in propping or dampening portfolio returns. Hence, these funds can, at best, be your ‘next-to-nucleus’ funds that accelerate overall portfolio returns.

The core funds, such as HDFC Equity, Birla Sunlife Equity, Magnum Contra or Reliance Vision, may well do the job of providing returns with lower risk and without any need to time entry or exit. After all, one of the core objectives to mutual fund investing is that market timing should not matter.

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