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NFOs still have promises to keep

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Quite a few new funds under-performed their benchmarks over the last year or so. However, with the frequent reversals in the market and considerable churn in the sectors leading each rally, the past year has been challenging, even for established equity funds.

Vidya Bala

The several bull-phases in the stock market in the last couple of years appear to have increased the interest of investors in equities. Mutual funds were quick to tune into this and have come out with new fund offers (NFO) with increasing regularity. And they have not been disappointed. The new funds have mopped up huge sums from investors. Between October 2005 and September 2006 alone, about Rs 32,000 crore (36 per cent of the total equity fund sales in that period) was collected by equity NFOs through open- and close-ended schemes.

Have the new funds lived up to their promise? How have they compared with funds that have a track record? A

Business Line

analysis reveals that quite a few of the new funds under-performed their benchmarks. However, with the frequent reversals in the market and the considerable churn in the sectors leading each rally, the past year has been challenging, even for established equity funds.

The analysis considered only funds launched before September 2006 less than six months being too short to evaluate performance. However, investors need to note that this exercise cannot form a sufficient basis for investments in these funds. It can, at best, be seen as a performance tracker.

A Flavour Not Savoured

In the open-ended category, infrastructure and engineering were clearly the pet themes among fund-houses for new fund offerings. About seven funds were launched under this banner. The timing of the launch for most of these funds was not too good, as market conditions played the spoilsport (infrastructure and engineering stocks trailed the Sensex from May till date).

Barring Sundaram BNP Paribas Capex Opportunities and CanInfrastructure, launched in September and December 2005 respectively, the rest of the theme funds debuted in March-April 2006, when the market was at its peak. With the May correction and the ensuing volatility in the sector, the rest of the bunch turned in single-digit, or even negative, returns from inception till February 2007.

Funds such as Tata Infrastructure, Reliance Diversified Power and DSPML T.I.G.E.R launched in 2004 did a better job of riding the theme at the right time and have a reasonable performance record.

While the infrastructure idea is yet to lose steam from a long-term perspective, as the Government continues to place emphasis on spending in this segment, the massive re-rating this sector underwent is unlikely to repeat itself. Hence investors need to consider their risk appetite and watch if the funds deliver commensurate returns in the coming quarters. This may be crucial to decide whether to stay with these funds or move to diversified equity schemes.

Among the other theme funds, PruICICI Services Industries has climbed to the top over the last six months. The tilt towards IT stocks, coupled with greater diversification compared to other service theme funds paid off well. Kotak Lifestyle, which invests in stocks likely to benefit from consumer spending, has also improved performance and has a promising basket of stocks.

Diversification Helps

For those who stuck to new diversified funds, it was a mixed blessing. There was no unifying theme or market-cap focus that took a new fund to the top performers list. However, funds such as Standard Chartered Premier Equity, Templeton India Equity Income, UTI Leadership Equity and Fidelity Special Situations were among the top performing NFOs over a six-month period.

Templeton India Equity Income has, true to its mandate, invested in foreign stocks (about 27 per cent of its assets) and returned 16 per cent since inception till date , against its benchmark BSE-200's return of 10 per cent. While the global markets are becoming increasingly inter-linked, the fund's ability to identify markets and stocks that can perform better than the Indian market would be the key to successful diversification.

Another diversified large-cap fund, UTI Leadership, has also steadily gained ground and appears to mimic the investment strategy of established funds such as Franklin India Prima Plus. Other new funds in the category, such as SBI Bluechip and Standard Chartered Imperial Equity, failed to impress as they appear to lack a focussed strategy.

The fund's objective and track record are as important in a tax saving fund as in any other fund. Among the six new tax-saving funds, Kotak Taxsaver, with 24 per cent returns since inception in October 2005, attracted attention for its ability to deliver returns comparable to diversified funds, despite a bias towards mid-caps that have under-performed the past nine months. Those such as DWS Tax Saving and DBS Chola Taxsaver failed to make a mark.

No containing downside

NFOs during this period were witness to a very volatile phase in the market in May/June 2006. The new funds in that period lost an average of 32 per cent between May 10 and June 14, against the Sensex decline of 29 per cent. So, which of the new funds managed this phase well?

The performance round-up for the June 2006 quarter showed that among the new funds, only Reliance Equity and Quantum Mutual, which held a significant proportion of cash, contained the declines. The rest of the funds fell more than the market. Ironically, the new contra funds from the DBS Chola, UTI and Tata fund houses also fell with the rest, despite a specific focus on "value" or contrarian investing.

Despite attractive valuations for these stocks, contrarian exposures in oil and gas once again failed to pay off during this period. Some of the other seemingly contrarian picks in the mid-cap space succumbed to market pressure. This is only to be expected as the rally continues to be narrow, while declines are broad-based.

Closed doors

Closed-end funds gained favour over the past year, with more fund houses rolling out closed-end NFOs.

However, these funds, as a category have turned in a disappointing performance. Of the eight closed-end schemes launched during the period of this analysis, five were launched after the May episode. Of the eight, only PruICICI Fusion, with a mandate to invest across market-caps and a return of 9 per cent over the past six months, has shown some promise.

While it may be too early to analyse their performance, funds such as Standard Chartered Enterprise Equity (seeking to invest in IPOs) and Franklin India Smaller Companies have delivered unimpressive returns of 6 per cent and - 1.9 per cent respectively, since their inception.

Investors in these funds have little choice but to hold on, as the cost of exiting such funds at an early stage can be quite high, apart from any erosion in capital. This reinforces the view that theme funds or funds with a restricted mandate may not be well suited to the closed-end structure.

NFO checklist

We have maintained that there are a good number of established funds with a sound track record for retail investors to build their portfolios. If the at par or Rs 10 per unit factor lures you, resist it.

If the NAV is low, it is only because the fund is yet to make a beginning with building its portfolio. Existing funds have higher NAVs because their portfolios have appreciated in value since inception. However, if one wishes to go for new funds the following need to be kept in mind:

Is there

anything new that the fund has to offer that existing funds do not? If it is an old idea, a performing fund would hold less risks than an unknown one.

Does the

fund come from an established house and has its manager had successful stints elsewhere?

Does the

fund's stated investment strategy suit your risk profile? A small-cap fund, for instance, is likely to witness high volatility and may be unsuitable for low-risk investors.

Are the fund's

expenses similar to peers in the market?

If you do choose one after considering the above, make sure that NFOs form only a small portion of your portfolio, to minimise the risk of the unknown.

(This article was published in the Business Line print edition dated March 11, 2007)
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