The Hindu Business Line : Getting their act together

Most equity funds kept several steps ahead of the indices, and average returns perked up considerably. A mix of diversified and theme funds could have lent sparkle to your portfolio in 2007.

K. Venkatasubramanian

After a sedate 2006, in which they lost the battle with the benchmarks, equity funds made a strong comeback in 2007. Not only did most fund managers stay several paces ahead of the indices, average returns also perked up considerably.

On an average, diversified equity funds delivered a return of about 60 per cent in 2007, the majority beating the benchmark indices. In 2006, the average return was only about 34 per cent, though market returns were almost the same.

However, there was a big divergence in performance, with returns ranging from the teens in some cases to more than 120 per cent, in the case of the top performer. Thematic funds, particularly those focused on the infrastructure space, continued to deliver superior returns.

Funds that took advantage of opportunities across market capitalisation ranges topped the category. Here is a look at the performance of funds across categories.

Four out of five

Of the 159 diversified funds — including tax-saving and mid-cap funds — as many as 128 funds, or four out of every five, managed to outperform the Sensex returns (47 per cent) in 2007.

Take the Nifty returns (55 per cent) into consideration and the number of funds that outperformed drops to 95. Only 55 funds emerge victorious against the broad-based BSE-500 (63 per cent).

This may be explained by the fact that although Sensex stocks delivered decent returns, the rally in the later half of the year included several non-index stocks. Funds that moved into large-cap stocks and index heavy-weights may have missed out on mid-cap out-performers. In that light, BSE-500 may be a better benchmark for this period.

Taurus Libra Taxshield, StanChart Premier Equity and Taurus Discovery managed to double investor wealth. Except Taurus, which has three of its schemes in the top 10, the other seven top rankers had representation from all fund-houses. This indicates that schemes from across houses have been able to spot out-performers, and benefit from any potential gains.

Flexicap approach: An analysis of the top 10 performing funds reveals that only four of them are predominantly large-cap focussed, Kotak Opportunities and DBS Opportunities were among such funds. The other funds seem to be heavily mid-cap biased, and have been able to benefit from the rally in this segment. This despite the fact that the funds do not have a specific mandate to invest in mid-cap stocks alone.

Overall, funds that invested in a blend of large-, mid- and small-cap stocks such as Reliance Regular Savings and Sundaram SMILE have managed a better performance relative to the Sensex or the Nifty.

Funds that followed this “flexi-cap” approach typically had a small and manoeuvrable asset base; most funds in the top 20 had a corpus of less than Rs 500 crore.

Funds with smaller asset bases can buy and sell mid/small-cap stocks without incurring heavy impact costs. Larger funds, on the other hand, need to transact higher volumes in a stock for a similar stake and, in the process, incur higher impact costs, thus affecting their NAVs.

Choice mattered: Not all investors have reason to be pleased with fund performance, however. While the top 10 funds delivered an average 95.2 per cent return, the bottom 10 scrounged together a mere 30.2 per cent.

This huge gap in returns meant that an investor’s choice of funds would have made a material difference to his portfolio returns in 2007. As many as 31 funds under-performed the Sensex, a lenient benchmark by itself .

Mid-cap funds: The performance by funds with a specific mandate to invest in mid-cap stocks has come as bit of negative surprise. Of the 22 exclusive mid-cap funds, only three (Birla Midcap, Sahara Midcap and Magnum Midcap) managed to beat the BSE Midcap return of 68.6 percent. (But they did comfortably beat the Sensex). Funds that stuck rigidly to the mid-cap market capitalisation range have not outperformed the benchmark, at least not by a large margin. On the other hand, mid-cap funds that had the flexibility to invest a small portion of their assets in large-cap stocks notched up better returns. Many large-cap stocks did exceedingly well last year, L&T and BHEL for example. Mid-cap funds that timed their entry into key stocks and sectors well managed to outperform the index.

The key takeaway is that in a broad-based rally such as the one in 2007, investors may be better off sticking to diversified funds with a flexicap approach rather than those with pure large-cap or mid-cap mandates.

The liquidity of these stocks may also not be very high making exit options difficult for funds. Thus, investing in plain vanilla diversified funds would create a wider window of opportunities for investors and reduce the importance of timing the market.

Theme funds sizzle

Theme funds were the toast of the year. There are as many as 15 funds with infrastructure or related themes, making the choice difficult.

Power, construction, capital goods, metals, and engineering sectors being top performers last year, funds focussed on these sectors delivered superior returns.

Interestingly, if the BSE Capital Goods index were used as a benchmark, only Reliance Diversified Power Sector fund managed to beat it in returns.

Even the BSE Metals or BSE Oil & Gas were difficult benchmarks to beat. But these funds did beat the Sensex, Nifty and the BSE 500 quite comfortably.

Banking sector funds did well — there are just three in this category — beating the benchmark BSE Bankex and other broader indices as well.

Theme funds have the potential to perk up returns of your portfolio substantially but come with a higher risk profile. They may substantially outperform in a short time-frame, but could melt down if specific themes go out of favour.

Hence, timing and the holding period become critical to get the maximum mileage. It might be better to follow an active profit-booking strategy here.

Moves that worked

The best performing funds were on top, mostly on account of their stock selection.

Among stocks, those from the Reliance group/s proved to be the trump cards, with most funds having one or more of these: Reliance Industries, Reliance Capital, Reliance Energy and Reliance Communications. These stocks have led many thousand-point rallies in the indices over the past year.

Stocks such as L&T, BHEL, Areva T&D, ONGC, Tata Steel, ABB and Sterlite Industries are some prominent picks of the funds in the large-cap segments. But there were stocks in the mid-cap segment (a few in the large cap as well) that have increased in price by 2-7 times over the past year that most funds had in their portfolio. These include stocks such as IFCI, Jai Corp, JP Hydropower, Aban Offshore, ABG Infra and IDFC.

Stocks such as Deep Industries, Alphageo, Sintex, Educomp, Jindal Steel and Power, JSW Steel, Welspun Gujarat, and Gujarat NRE Coke were favourites with some of the top-performing funds.

In terms of sector weights, software and automobiles and auto ancillaries saw exposures being lowered to a half or a third of their previous year’s exposures.

Barring select top-tier IT stocks, which saw paring of exposure, no Tier 2 IT stock had any serious exposure in the funds.

Most diversified funds also had heavy exposures to ‘in’ theme sectors. Telecom, too, has seen pared exposure, and so was the case with pharmaceuticals.

Turning tide

Dividend yield funds, though only five in number, which had under-performed in 2006, did better last this year. Two of them are in the top quartile of the fund ranks and four have managed to beat Sensex and Nifty returns.

Media and real estate, two sectors that did well in the past year, did not have too many of their stocks included in the funds.

That diversified equity funds managed a better performance in 2007, despite the Sensex returns being the same, shows that funds do seem to have gotten their act together in 2007.

With mid-caps participating actively in the rally, the strategy of casting the net wider for investment options appears to have worked.

2007 was a year in which a mix of diversified funds and well identified theme funds, could have worked wonders for your portfolio.

Related Stories:
Review of five-year performance: Equity funds for all seasons
Diversified equity funds close to 52-week peaks
Diversified equity funds' assets cross Rs 1 lakh crore

More Stories on : Stock Markets | Insight | Mutual Funds

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
Positions versus postures

Future Capital Holdings – IPO: Avoid

Taking the common man to Nano-sphere

SBI Bluechip Fund: Switch

Reliance Power — IPO: Invest

Gitanjali Gems: Buy

Ansal Housing and Construction: Buy

Carborundum Universal: Buy

Index Outlook

Getting their act together

Fusion investing for optimal gains

How equity funds are different from stocks