The Hindu Business Line : Breathless chase of the indices

Stock selection played a key role in fund performance over the quarter. A few aggressive funds that churned their portfolios and bought the right stocks made it to the top, while the more diversified funds notched up average returns.

Shanthi Venkataraman

It is becoming increasingly difficult for mutual funds to keep pace with the effervescent markets, as is clear from their performance in the July-September quarter. The period also saw the Sensex tumble close to 10 per cent and then recover at a stupendous pace, climbing nearly 20 per cent in a month’s time to cross the 17,000 mark. The market rebound was so swift that most funds were caught trailing the indices.

The average diversified equity fund delivered a return of close to 14 per cent in the quarter. With returns like that, who can complain? But, measured against the Sensex, the main benchmark for performance, funds did not fare too well.

Barely 15 per cent of the 165 equity funds in the diversified category beat the index, which returned 18 per cent during the period. Less than a third outpaced the Nifty. Performances did not compare too well with broader benchmarks such as the BSE-200 or CNX-500 either.

Lagging the benchmarks

The intermittent market correction was in itself not so bad. Funds even managed to contain the declines better than the benchmark index. But they could not beat the indices during the recovery phase.

While an unprecedented flow of foreign money propelled the markets to new highs, the rally remained extremely selective. Stock selection, therefore, played a greater role in determining fund performance during the quarter.

So did timing. From the August lows, the Sensex gained 19 per cent on the back of a thin rally, led by Reliance, ADAG and their group companies. A few aggressive funds were able to churn their portfolios, buy into the right stocks and make it to the top. Those funds that stuck strictly to their mandate and remained well diversified, however, delivered more average returns.

No dominant theme

No single sector or theme dominated the portfolios of top performing funds. Funds in the upper quartile generally had exposures to banking, metals and oil. But holdings in these sectors did not guarantee performance, as stock choices mattered more. This may have been a quarter when the much-touted bottom-up approach would have been the better investing strategy than a top-down style, with offbeat picks such as Adani Enterprises, Apollo Tyres and United Phosphorous delivering stellar returns.

Among theme funds, the infrastructure theme continued to do well. Magnum COMMA was another theme fund that impressed, as it was well-placed to capitalise on the rally in commodity stocks.

Other themes that focused on lifestyle and consumption, services industries and international investing, however, delivered subdued returns. Pure sector funds continue to hugely under-perform the diversified funds. There were also no prominent cap biases in the performance chart. Neither large-cap funds nor mid-cap funds raced to the top of the performance rankings this quarter.

This is because the Sensex and Nifty as well as broad-based indices such as the BSE-200, CNX-500 and CNX Midcap sported similar returns during the quarter.

With the rally being selective, a cherry-picking strategy from both large-cap and mid-cap segments seems to have worked.

While pure large-cap funds figured in the middle of the rankings, several mid-cap funds fell to the bottom of the list. Mid-cap stocks as a category have still not fully participated in the ongoing rally, with larger companies continuing to remain in favour.

Mid-cap funds, mixed bag

The selective rally in mid-caps may explain the divergent trends in performance within the mid-cap fund category. While JM Small & Midcap Fund, Birla Midcap and Magnum Midcap beat the BSE Midcap Index and delivered above average returns, the likes of Kotak Midcap, ICICIPru Emerging STAR and DSP ML Small and Midcap turned in single-digit returns. Stock selection may have played a greater role in mid-cap fund performance than sector choices.

For instance, although Kotak Midcap was overweight on banking and metals, which have been the top performers in the recent rally, the fund was a major underperformer due to its weak stock selection. On the other hand, though JM Small and Mid-Cap Fund did not have any exposure to banking and hardly any holdings in metals, it still managed to outperform the category through superior stock choices.

All in the family

The rankings also revealed interesting trends in fund-house performance during the quarter.

Essentially, funds belonging to a particular asset management company tended to sport similar returns.

For instance, almost all funds under the Sundaram BNP Paribas Mutual Fund banner figured in the topmost quartile of fund rankings, with the exception of Sundaram BNP Paribas Midcap. A similar trend can be noticed in the case of Deutsche Asset Management, JM Mutual Fund, SBI Mutual Fund and Taurus Mutual Fund.

Most Sundaram BNP Paribas Funds rode the rally in the Reliance stocks. Almost all its portfolios also had picks such as Welspun Gujarat, Sesa Goa and Thermax, which were among the top performers in the mid-cap space.

Several portfolios of funds belonging to JM Mutual Fund, well known for its bias towards mid-cap stocks, had a sprinkling of favourites such as Sintex Industries, Gitanjali Gems, Apollo Tyres and Bharati Shipyard.

Most of these top performers are fund houses known for their dalliance with mid-cap stocks and tend to have a more aggressive management style, which has probably worked in their favour amidst volatile markets.

The trend points to a similarity in investment strategies across funds within a particular fund-house. Such funds probably adopt the house view on markets and sectors. That several funds are managed by a single fund manager could be another explanation for this trend.

Either way, the trend highlights the need to spread your investments across fund-houses to really diversify your portfolio.

Conclusion

Funds may have underperformed their benchmarks. But investors need not treat them too harshly just yet, as performance has been evaluated only over a short period. The findings in this quarter are diametrically opposite to that in the April-Junequarter when a majority of the funds outperformed the indices. Again, mid-cap funds were actually at the upper quartile of the rankings during that period. This goes to show that no serious conclusions can be drawn about fund performances in a single quarter.

In the Indian context, funds have often outperformed the indices. Indices were poorly constructed, remained largely static, and funds could simply pick stocks outside the indices to outperform.

But in the last two years they have found it hard to do so. This is because large-caps have remained in fancy and a narrow set of stocks has been constantly re-rated. Mid-cap stocks, on the other hand, barring a few, have not delivered particularly outsized returns.

Sections of the industry also attribute this recent underperformance to the fact that the indices are now more dynamic.

The composition of the indices is frequently changed, as performing stocks enter the index and underperformers are booted out. Beating this changing portfolio has become a more difficult target to achieve.

Still, the case for active investing remains strong. While passive index funds have done well as a category, with 16-19 per cent returns on an average during the quarter, investors who held the likes of Sundaram Select Focus, JM Emerging Leaders or Birla Sun Life Basic Industries, may still vouch for active fund management.

But selecting the right funds and timing your investment right may play a greater role in propping up your portfolio returns.

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