The Hindu Business Line : Bad quarter for mutual funds: Diversified funds may hold key

Though mid- and small-cap stocks have corrected to attractive levels from a valuation perspective, investment in diversified equity funds with large-cap bias appears to be a better bet for investors at this juncture.

K. Venkatasubramanian

The first quarter of this year was a turbulent one for the equity market, a fact clearly reflected in the performance of equity funds. Equity funds have failed to deliver positive returns in this period with just one scheme in 255 in this category registering a positive return. ICICI Pru Equity and Derivative – Income Optimiser, is the only scheme that has managed a positive 2.3 percent return.

The Sensex and Nifty each declined by 22.9 per cent these three months. In the same period, the best and the worst performing funds recorded a positive 2.3 per cent and a negative 41.7 per cent respectively.

Much of the following analysis, therefore, revolves around which funds have contained losses better and which have not fared as badly as the benchmarks.

International, sector funds rule the roost

International funds, those that invest a portion of their portfolio overseas, have performed better than most other equity funds, during the rout. These funds have all figured among the top 10 per cent in the return rankings for these three months.

Many Asian markets such as Taiwan, Korea and Japan have rebounded much more sharply than India since mid-March, after tumbling like nine-pins in the preceding months. These international funds, of course, have a limited history. Most of them still have less than 5 per cent in cash equivalents, indicating that they were almost fully invested in equity. Pharma and FMCG sector funds have also contained losses well during the quarter, thanks to their being viewed as ‘defensive’ sectors. These sectors have actually seen some buying interest in recent months, after a long spell of underperformance.

But investors probably shouldn’t buy these funds at this juncture; as the interest may peter out when the broader market recovers. Diversified funds may yet give investors a better exposure to these sectors.

Mid-caps, tax-saving funds suffer

Mid-cap stocks and funds — the toast of last year — suffered badly this quarter. The CNX Midcap index lost 33.5 per cent in value over the quarter, much more than the Nifty. But barring three funds — Reliance Growth, Birla Midcap and Stan Chart Premier Equity — the rest of the mid-cap funds have straggled behind this benchmark. Investors can take heart from the fact that the extent of under-performance is not very pronounced, at 2-4 percentage points.

The Jan-March quarter normally sees investors searching for tax-saving funds. But such funds have continued their indifferent run. No tax-saving fund has beaten the Sensex or the Nifty in returns this quarter. The main reason for this underperformance is that such funds have packed their portfolios with mid-cap stocks (less than Rs 7,500-crore market capitalisation). Not that large-cap stocks had a great time, but mid-caps had a poorer run. Tax-saving funds invested anywhere between 20 and 40 per cent of their total portfolios in mid-caps in recent times.

Infrastructure funds

Contrary to expectations, theme funds focussed on infrastructure did fare worse than diversified funds this quarter. Their average decline was 30.7 per cent.

Only four infrastructure funds of the 14 fell less than the BSE Capital Goods index, which dipped 29 per cent. Prominent out-performers were Reliance Diversified Power Sector and ICICI Pru Infrastructure.

Funds that included oil and metals sectors to capitalise on the “infrastructure story” suffered, as these indices lost 24.6 per cent and 30 per cent respectively.

Credit crunch, fears about execution delays and rising commodity prices all played their part in raising concerns on the infrastructure story. If you thought investing in Index funds — those that try to replicate the Sensex or Nifty — would have limited your losses to the extent of the market, you may have been in for a few disappointments.

Index funds still LAG

For, continuing their lacklustre performance, only two index funds matched or bettered Sensex or Nifty returns. Where does all this leave the investor?

In the light of the market turbulence, here are a few factors for investors to consider:

Though mid- and small-caps have corrected to attractive levels from a valuation perspective, investment in diversified equity funds with large-cap bias appears to be a better bet at this juncture.

First, large-cap stocks, being more liquid than mid- or small-caps, may carry lower impact costs at this point in time, making them less susceptible to wild swings. Second, these stocks may also be the first to participate in a market uptrend.

Third, large-cap companies, due to their size and scale, may better weather macro risks such as a demand slowdown or escalating commodity and input prices, allowing for greater certainty on earnings front. Mid-caps and small-cap stocks are less liquid and such companies are subject to higher fluctuation in earnings.

With the earnings season round the corner, this volatility may only be heightened.

Investing through the systematic investment plans of large-cap funds with a good track record may help investors gain from market upside and average unit costs during downside.

Investors with a low risk appetite may reduce their exposure to theme funds and switch to diversified funds, as the latter may have greater flexibility to move across sectors based on their earnings outlook.

Our picks from diversified equity funds: DSPML Top 100 Equity, HDFC Top 200, HSBC Equity, Birla Frontline Equity, Reliance Vision and Sundaram Select Focus, by virtue of their large-cap focus and good track record, may qualify to be part of your core portfolio.

Small amounts may also be invested in international funds as a diversification measure.

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