The Hindu Business Line : Fund Talk

It is a good strategy to replace your underperforming equity funds with index funds, as you will then be assured of earning at least the index return.

I read with interest your column on entry loads last week. I recently started making most of my mutual fund transactions online(through the fund’s portal) and most of my transactions are now treated as ‘direct’, leaving me free of entry load.

I am a retired person and fortunately have received assistance of a highly capable distributor/agent. I would not completely do away with him. During the last eight years of my investing in diversified equity funds, index funds, debt funds and liquid funds, I have reaped fairly handsome rewards. It has been a much more satisfying experience than dealing directly in stocks.

I now seek your guidance on a very pertinent point. Nearly 40 per cent of my equity diversified fund investments (example, HSBC Equity Fund, Sundaram BNP Paribas Select Focus, and ICICI Pru Infrasructure Fund) are underperforming the index funds. So why shouldn’t I switch? My contention is that the index funds are free from entry and exit loads so I can switch back at any point of time. Other funds I have investments in are DSP BlackRock Equity, Franklin India Bluechip, Franklin India Prima Plus, HDFC Top 200, Reliance Diversified Power Sector, Reliance Growth and Magnum Contra, besides debt and gilt funds.

U. S. Dubey, Noida

It is good to see an investor who has such a balanced and long-term approach to equity funds. You are right in saying that some diversified equity funds have underperformed index funds in recent times. Diversified equity funds, after managing to comfortably outperform benchmarks until end 2007, have not acquitted themselves very well over the past one year.

The average three-year returns managed by diversified equity funds as a category now stand at 11.5 per cent against the 13.7 per cent managed by the Sensex. The severe market meltdown of 2008 prompted many of the Indian equity funds to turn extremely defensive in their strategies.

Not only did many funds increase cash positions to an all-time high, many loaded up their portfolios with defensive sectors such as healthcare, FMCG and technology which have remained mainly on the sidelines of this rally. That has resulted in a good number of funds trailing the bellwether indices. However, the good news is that funds have deployed much of their excess cash in the past month and have seen their returns improve and catch up with the indices as a result.

As a strategy, we would not advocate shifting entirely into index funds and completely avoiding actively managed ones for a long-term investor. The reasons are twofold.

One, going by the five year track record of funds as well as the fact that mid- and small-cap stocks offer such high return potential in India, you can earn a higher long-term return on your equity portfolio by holding diversified funds which have a mix of large- and mid-cap stocks in their portfolio.

Two, as index funds manage to exactly replicate index returns, good timing on the part of the investor is even more important while investing in index funds, than in the case of diversified funds.

Funds such as Sundaram Select Focus, HSBC Equity and ICICI Pru Infrastructure have seen a slippage in their performance relative to peers over the past year. Therefore, it is a good strategy to replace your underperforming equity funds with index funds, as you will then be assured of earning at least the index return.

We however urge you to examine the track record of the index funds that you are considering quite carefully. As open end index funds in India tend to have a high tracking error, it is best to assure yourself that the fund you selected, has indeed mirrored the index faithfully.

Buying Exchange Traded Funds through the stock exchanges is the most effective and low-cost option to capture index returns in the Indian context.

AARATI KRISHNAN

More Stories on : Mutual Funds | Mutual Funds

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