As the performance of NFOs has not been as good as established funds, investors holding older funds may only have duplicated portfolios and dragged down their returns by taking exposure to the former.

Vidya Bala

Despite the number of open-end equity funds available expanding manifold over the years, the investors’ fascination with New Fund Offers (NFOs), which are offered at Rs 10, has scarcely waned. But if you gave in to lure of new fund offers over the past couple of years, chances are that your investments are today in the red.

While investors in the 2005 or 2006 crop of NFOs may have a positive return to show, those who succumbed to NFOs in 2007, or later, may have no choice now, but to wait for the long haul. Only two of the 25 open-ended equity funds launched in 2007 have managed NAV gains since inception, due to their launch in relatively benign market conditions. ( The 2008 NFOs were not considered for the analysis, given their short track record since inception).

Reviewed here is the performance of open and close ended NFOs since 2007 against their benchmarks. One trend to take note of is that fund launches in the open-ended category were dominated by diversified equity funds and not theme funds. Funds centred on themes such as infrastructure, energy, small-cap or lifestyle, were launched through the close-ended category.

New fund houses such as Lotus and JP Morgan made their debut, though not with entirely new product ideas. Existing fund houses, however, offered some differentiated products as they sought to expand their menu: Birla Sunlife International Equity, which had the flexibility of a 100 per cent allocation to global equity, or HSBC Dynamic, with a mandate to dynamically shift between equity and debt, stood out for their new strategies. Close-ended small-cap funds were also the fancied theme for many AMCs.

The positive news is that most of the funds that garnered over Rs 1,000 crore did not disappoint too much.

Big-ticket players

Funds such as Reliance Equity Advantage, Birla International Equity and Fidelity International Opportunities, which collected over Rs 1,000 crore, are among the better performers. However, AIG India Equity and Franklin India High Growth Companies failed to impress, with year to date losses of about 35 per cent.

That investors were unwilling to wait for these funds to perform was evident from the shrinking assets of even the better funds. The better performers too witnessed a decline in asset size which was higher than the decline in per unit NAV, suggesting that investors were turning nervous and resorting to redemption.

In the close-ended category, HDFC Mid-cap Opportunities and UTI Lifestyle came up to expectations after their huge NFO collection.

How they fared

Open-ended equity funds that made their debut in 2007 recorded returns that ranged from a positive 11 per cent to a negative 57 per cent from their inception. The best among them was DSPML Taxsaver, the worst being JP Morgan India Smaller Companies. New funds, on an average, have had 25 per cent shaved off their NAVs over the past six months.

As a category, these funds didn’t fare much worse than their long established peers — as the category average for diversified equity funds also stood at a negative 25 per cent for this period. However, the investor’s choice of funds from the NFOs of 2007 would certainly have a made a big difference to his returns. There has been significant divergence in the performance of new funds.

Three out of every five funds declined much more than the 25 per cent average mentioned above, suggesting that only a few good numbers helped prop up the average. In the roller coaster markets of the past year, the new funds declined by 2-20 per cent. DBS Chola Hedged Equity and DSPML Tax Saver were the only funds that managed declines within the 2 per cent mark.

This performance is still not too encouraging as at least 20 of the established equity funds notched up better returns than the best performing new funds. Investors may, however, need to note that selecting stocks or sectors that would outperform may have been much more challenging for the managers of new funds amidst unfavourable macro and market conditions.

While plain vanilla equity funds fared as well or as badly as their established peers, one theme that delivered was “international” investing. Birla Sunlife International Equity Plan A declined the least in the past six months.

The fund has the flexibility to invest its entire corpus overseas (most other global funds restrict investing overseas to 35 per cent, with an eye on the tax benefits), and this has helped the fund in a scenario where Indian stocks tumbled more sharply than most global stocks. While the diversification certainly helped its performance, the fund’s 20 per cent holding in cash and debt was also a key factor in mitigating declines.

Schemes with promise

Given the volatile market conditions during the period, most of the funds struggled to beat their benchmarks. Among the open-ended funds, only Fidelity India Growth, HSBC Dynamic and Reliance Equity Advantage resolutely managed to decline less than their respective benchmarks (over 3-month, 6-month and 1-year periods).

What worked in favour of these funds? Differing strategies — ranging from tactical cash allocation to the right sector choices. HSBC Dynamic holds as much as 30 per cent in cash and other instruments, taking advantage of its mandate to allocate dynamically between debt and equity, based on market conditions.

Fidelity India Growth, with its house strategy of holding a widely diversified portfolio and with a mix of defensives such as technology consumer goods and healthcare, decisively beat the BSE-200. Reliance Equity Advantage did well with a complete large-cap portfolio of oil and technology stocks. Except for HSBC Dynamic, the other two funds were almost fully invested in equities since their launch and during corrective phases as well.

Discouraging show

A tilt toward large-cap stocks however, was no great help. The quant-based Lotus A.G.I.L.E (Alpha Generated from Industry Leaders), with a portfolio laden with large-caps, fell over 40 per cent on a year-to-date basis. Heavy exposure to stocks in sectors such as infrastructure, power equipment and power pulled down the fund’s performance as these sectors bore the brunt of the bear market.

Among the mid-cap funds, JM Small and Mid-cap Fund was among the worst hit, underperforming its benchmark by a huge margin. This was the only small-cap fund that took the open-ended category, as others in the space safely chose the close-ended route.

Among the tax-saving funds, DSPML Taxsaver contained declines better. However, all of them continue with the strategy of a tilt toward mid-caps. A good 40-50 per cent of the assets of the new tax-saving funds was invested in mid-caps. Hence, their risk profile appears similar to the earlier ELSS schemes.

Close-ended no different

With no fluctuating corpus or panicky investors clamouring for redemption, did closed-end new funds do better? Not really. Though investors in these funds were effectively locked in for 3-5 year terms, closed-end funds launched in 2007 lost just as much value as their open-ended peers. About 26 such funds launched in 2007 fell by an average 27 per cent over the last six months — marginally worse than the average of 25 per cent registered by open-ended funds.

Funds such as IDFC Taxsaver and Sundaram BNP Paribas Equity Multiplier held on to positive returns since their inception. ABN Amro Sustainable Development Fund and Escorts Infrastructure were among the worst hit.

Closed-end funds trailed their respective benchmarks by a bigger margin. Given that a good number of funds launched were either mid- and small-cap focussed or sector funds, this is probably no surprise. The surprises come from funds such as HDFC Mid-Cap Opportunities and Sundaram BNP Paribas Select Smallcap, which, though they declined sharply, performed better than their benchmarks (between January and July), despite some aggressive bets in the small- and mid-cap segments.

Go slow on new funds

So, what message should investors take home from the NFO performance? One clear message is: If you are looking for vanilla diversified funds, stick with the tried and tested ones. As the performance of NFOs has been somewhat inferior to established funds, investors holding older funds may only have duplicated portfolios and dragged down their returns by taking exposure to new funds.

Added to this, investors in new funds may have to wait longer for these funds to deliver a turnaround, given that many of them haven’t yet experienced a complete market cycle. While some of the new funds may have learnt to contain declines better, their ability to detect a rally and take the right sector and stock calls is yet to be tested. This could be the crucial factor, as it is in a rising market that a fund manager’s ability to take active calls and generate alpha (market-beating returns) comes into play.

As mentioned earlier, it is the new funds with differentiated products that have staged noteworthy performances. DBS Chola Hedged Equity, with an active hedging strategy, or HSBC Dynamic, with tactical shifts between debt and equity, are instances. The above funds, together with the international funds (as a diversifying measure), may be worth a wait.

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(This article was published in the Business Line print edition dated August 3, 2008)
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