MUTUAL FUNDS: MANY MILES TO GO

After a few years of subdued performance, the last financial year has been good for the equity market in general and the mutual fund industry in particular. The frontline equity indices gave a return of 24.5 per cent, highest since FY10. The rising equity market helped equity mutual funds attract inflows of over Rs 71,000 crore in FY15 on the back of better performance. This mobilisation along with the mark-to-market gains led to the total average asset under management (AUM ) under equity schemes to reach an all time high of Rs 3.45 lakh crore. The funds raised through new fund offers (NFOs), which is included in the data accompanying this report, was at Rs 15,400 crore from 84 equity NFOs in FY15. Out of this, a major part (almost Rs 11,500 crore) was collected by 58 close-ended equity schemes. This mop up of funds helped to add over 30 lakh equity folios last year (FY15).

Regardless of all the gains that we have highlighted in the above paragraph, investment in mutual funds is still not the first choice and preferred route of investment for retail investors in India. According to a study done by Nielson in 2014, only 9 per cent of urban Indian households invest in mutual funds and the figure is even lower for rural households. Investment in bank fixed deposits (42 per cent), post office savings (24 per cent), and other forms of savings rank higher than investments in mutual funds.

So what is stopping Indians from investing in mutual funds? According to the report, it is the low level of financial literacy that makes potential investors believe that mutual fund investment is more risky and hence this path is viewed with suspicion and caution. The fear and risk-aversive attitude of an individual is what limits the mutual fund industry to attain its full potential. The market regulator, Securities Exchange Board of India (SEBI), has taken cognizance of this issue and mandated all asset management companies to set aside at least two basis points or 0.02 per cent on daily net assets for investor education and awareness initiatives. This amount, however, should be within the maximum limit of the total expense ratio. Nudged by the SEBI, many fund houses have taken innovative steps to educate retail investors, including Reliance Asset Management (‘Jab We Invest’) and Tata AMC (‘Professor Simply Simple’) who have exclusive websites to educate investors in a fun and friendly manner.

Investor education initiatives go a long way in making investors open up to the benefits of investing in mutual funds. We are already seeing the impact of such initiatives taken a couple of years ago. According to an AMFI statistic of 2010, an equity fund remains locked in for an average of 18 months and around 60 per cent of retail investors remain invested in equity funds for more than two years. At the end of FY15, however, the situation was found to have improved and an age-wise analysis of equity assets shows that the quantum of money held by retail investors in equity funds for over two years has not only improved but is also the highest at 72 per cent.

This also reflects that retail investments are sticky unlike institutions which book profit at regular intervals. Even during the recent fall in the equity market, which would otherwise have led to withdrawals from mutual funds, we have actually seen an increase in their inflows. An analysis of the shareholding pattern of the last one year ending May 2015 shows that individual investors, including retail, HNIs and NRIs, have actually liquidated their position in direct equity and invested in mutual funds.
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There is no doubt that retail investors, over the last couple of years, are showing an increased familiarity and comfort with the basics of mutual fund investment. They are now more aware of their returns’ expectation and associated risks. Nonetheless, we believe that this is the beginning and much more needs to be done to widen the reach of mutual fund investments. According to some of the recent studies, there are a little over four crore mutual fund folios in India, comprising around 3 per cent of the total population, which is low compared to other emerging countries.

We even score low on the other metric of gauging the penetration of mutual funds i.e. the AUM to GDP ratio. At the end of May 2015, the AUM to GDP ratio for India was around 11 per cent compared to 77 per cent for the US, 40 per cent for Brazil, and 31 per cent for South Africa in FY14. It’s not only the lower penetration that is hurting growth; higher concentration too is a limiting factor. India’s top 15 cities contribute 87 per cent of the industry’s AUM and the top five (Mumbai, Delhi, Chennai, Kolkata and Bengaluru) contributed 74 per cent of the entire AUM a couple of years ago.

The above data clearly shows that there is lot of untapped potential for the Indian mutual fund industry. To exploit this huge opportunity, fund houses should continue with their investor awareness programmes and a definite sequencing and pacing should be adopted to tap the opportunities. Past experience has shown that fund houses, with a shift in demographic profile of Indian population, have launched new products covering new asset classes and investment strategies without much success. The reason being that investors are not aware of the merit of these products and do not understand how this fits into achieving their overall financial goal.

Therefore, financial awareness or literacy should always be preceded by innovation or launch of new products. Technology should be used as a pivotal tool to increase the investor base. For example, the infrastructure of stock exchanges can be used to purchase and redeem mutual fund units directly from AMCs on behalf of their clients. With 99 crore telecom subscribers, mobiles or tablets should be used by distributors or agents to reach out to investors in rural underpenetrated areas and even existing mobile banking solutions can be used to expand the scope for transactions in MFs. We believe that there are exciting times ahead for the mutual fund industry and if every stakeholder plays his role, we may see the Indian mutual fund industry achieving its potential.

Departing from our earlier issue wherein we used to give recommendation of schemes, this time along with schemes we are also listing the best fund managers Meet the rock stars of fi nancial world who have helped investors those who have invested in their funds to beat market returns consistently over longer-term. This is followed by recommendation of MF schemes.

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FRANKLIN INDIA HIGH GROWTH COMPANIES FUND

After growing at a subdued pace, the Indian economy recorded early signs of pick-up in the last fiscal. Although this was not reflected through India Inc.’ Q4 FY15 numbers, going forward we believe the growth in economy will definitely get translated into earnings. Franklin India High Growth Companies Fund, that primarily invests in high-growth companies which tend to grow their earnings at a fast pace, is one of the funds that will surely get benefited by the expected uptick in economy.

This does not mean that the fund has not been performing in the past. The fund’s performance since its launch in 2007 has been pretty respectable. It has been able to beat its category return in every time frame. For example, the category return in the last seven years has been 13.65 per cent and compared to this the fund has generated return of 18.13 per cent during this period. Even for the last six months the fund has generated return of 5.38 per cent as against 3.68 per cent category-wise. The fund has also been able to beat its benchmark, CNX 500, every year since its launch, barring 2008 when it underperformed by less than 1 per cent.

The performance of the last 13 quarters ending March 2015 shows that the fund has been able to beat its benchmark in both falling market (e.g. Q1 CY13 and Q3 CY13) as well as in the rising market. Only twice in the last 13 quarters has the fund underperformed its category. These returns are not generated by taking extra risks. The fund’s three-year Jenson alpha, which measures the risk-adjusted performance of the portfolio in relation to the expected market return, ending May 2015 is highest in its category at 16.8 per cent.

The primary factor that is helping the fund to outperform its category and benchmark is right sector allocation along with stock selection. The fund uses a mix of top-down and bottom-up approach to select right sector and stocks. The top-down approach focuses on the macro economy and it is used to identify the fast growing sectors while the bottom-up approach is used to identify high-growth companies. It uses valuation matrices such as EV/EBITDA growth rate, price-to-earnings growth rate, forward price-to-sales, etc. to zero down to the right stocks.

The fund’s portfolio mainly comprises large-caps that constituted around 62 per cent of the total stocks at the end of May 2015. The mid-cap and small-cap funds share the rest. In terms of number of stocks, the fund held an average of around 40 stocks over the past three years compared with 45 stocks held by its peers in the category. The fund is managed by Roshi Jain since July 2012 and R Janakiraman since March 2014. We recommend this fund to form core of your portfolio.
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TATA ETHICAL FUND

Many of our readers would be surprised to find a Shariah-compliant fund being featured as one of the best performing schemes. This surprise factor is due to the limitation under which they have to park their funds. The rules of investment are set in the Quran and these funds are prohibited from investing in companies engaged in the production of alcohol, tobacco, gambling and pork products. They also don’t invest in companies that profit from charging interest. This means that these funds cannot invest in one of the largest sectors, the banking stocks.

Despite all these limitations, Tata Ethical Fund, whose mandate is to invest in Shariah-compliant companies, has been able to generate decent returns for its investors. The fund has not only outperformed its benchmark or category but even the frontline indices. In the last three years the fund has generated total return of 27.18 per cent against the category return of 24.08 per cent. When compared to Nifty, the fund has underperformed only twice in years 2008 and 2012 in the last 11 years starting 2005, and in the rest nine years (including year till date 2015) the fund has outperformed the Nifty.

What is helping this fund perform well is its investment in technology, FMCG, engineering and healthcare sectors. These sectors contribute 17.63 per cent, 16.6 per cent 15.42 per cent, 13.6 per cent and 11.35 per cent respectively in the fund. These five sectors contribute up to almost three-fourth of the entire portfolio. These sectors have seen a strong performance in the last few years and companies under these sectors are among India’s best run companies and biggest exporters. A deeper analysis of this outperformance clearly shows that the alpha generated by the fund has been more due to better sector allocation rather than stock selection. Incidentally these are also the sectors that have shown a lower volatility.

Therefore, a study of the last three years’ risk-adjusted return shows that the fund has generated good returns with relatively lesser volatility. The Sharpe ratio for the fund stood at 1.97. Although a few sectors dominate the entire portfolio, in terms of companies it is fairly diversified. The fund held a total of 55 stocks at the end of May 31, 2015 and the top 10 stocks constitute 35.2 per cent of the portfolio. In terms of market capitalization, it is large-cap that dominates the portfolio with 60 per cent share while mid-cap contributes 34.27 per cent of the portfolio. Though the fund is for a specific sector of society, looking at the past performance and portfolio construction, we would like to recommend this fund to risk-aversive investors too.
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KOTAK SELECT FOCUS FUND

Kotak Select Focus Fund is the youngest fund that has made it to our list of recommendations. Launched in August 2009, the fund is yet to complete its six years. What is worth noting is that this fund boasts of the highest asset under management (AUM). Helping the fund to become large in such a short span of its existence is its impeccable performance. Since its inception it has been able to beat the benchmark every year. When compared to its category, the fund has been outperforming in the long term as its trailing three-year returns are 441 basis points higher than its category in the same period.

In the short term, however, the fund has underperformed its category but was ahead of its benchmark. The fund has also managed to do well during the bear phases of the market. It fell 22 per cent, not much compared to around 27 per cent fall of the benchmark during 2011. The best part of the fund is its consistency, where the fund has beaten the benchmark in 11 out of 13 quarters ending March 2015. Such returns are not generated by taking extraordinary risk. For the last trailing three years, the standard deviation - one of the ways to judge volatility in returns - of the fund is at 14.46 per cent compared to the benchmark standard deviation of 15 per cent. Even the Sharpe ratio, which measures returns generated against the risk taken, is at 1.54 against 1.14 for the benchmark.

What has helped the fund to perform is its right stock selection. Our study of investments by this fund in the last two years shows that 65 per cent of the time it has invested in a winning stock. The right sector allocation has also helped it to perform. The fund’s mandate allows it to choose select sectors to focus on and according to the latest portfolio details the fund is overweight on financials that forms 28 per cent of the total portfolio, followed by automobiles and technology. In the latest portfolio, the top five stocks accounted for 67 per cent of its assets. The fund currently has a total of 51 stocks in its portfolio, which is in line with the category.

It has a large-cap tilt, parking 76 per cent of its assets in large-cap stocks while the mid-cap exposure is at 20 per cent and small-cap exposure is at 3 per cent. Looking at the fund’s mandate to follow a concentrated sector strategy by investing generally in a few sectors that have the potential to grow, we have seen that the fund has also moved across sectors in the last few years and hence we recommend this stock to aggressive investors.
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ICICI PRUDENTIAL INDO ASIA EQUITY FUND

You must have surely heard the adage of never putting all your eggs in one basket, which, in plain words, implies that diversification works the best. This helps you to reduce your risk. Investing through mutual funds is one process of diversifying this risk. ICICI Prudential Indo Asia Equity Fund, however, provides diversification in ways other than other funds recommended in this report. The fund is mandated to invest in equity and equity-related securities (ADR/GDR) of companies which are incorporated or have their area of primary activity in the Asia Pacific region. The fund intends to invest 65 to 95 per cent of the money in shares listed in India and maximum up to 35 per cent of the total fund will be invested in the Asia Equity Fund.

This diversification has worked well for the fund. In 2011, when the year was not good for equity investors in India and the country’s frontline equity indices - the Bombay Stock Exchange (BSE) Sensex and the National Stock Exchange (NSE) Nifty - fell 24 per cent, this fund was able to arrest its fall to 15.05 per cent, a clear outperformance of more than 9 per cent. The low correlation between the economic fortunes of different countries has helped it to mitigate country-specific risks.

This does not mean that in a good year for equity investors it has underperformed the benchmarks. For example, in 2014 the fund beat the benchmark return by a good 19.25 per cent. Even when compared to its category, it has outperformed in every time frame, be it short term or long term. What has helped the fund to outperform is its right stock selection. In the last two years it has had a strike ratio of 64 per cent, which means that 64 per cent of time it has picked the right stocks. Despite generating good returns, the fund has not taken any unusual risk. The standard deviation of the fund for the last three years is 11.1 per cent compared to benchmark standard deviation of 16 per cent. The risk-return ratio is better captured by the Sharpe ratio, which stood at 1.96, calculated again for three years against 1.05 for the benchmark.

The current portfolio of the fund is equally divided between large, mid and small-cap. In terms of domestic and international stock selection, the fund at the end of May 2015 has invested 85.5 per cent in Indian equity and equity-related instruments while around 11 per cent is invested in foreign mutual funds. Looking at the track record of the fund and its investment mandate, we recommend this one for investors with a preference for moderate risk.
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MIRAE ASSET INDIA OPPORTUNITIES

This fund was launched in the first quarter of 2008 when the equity market around the world was going through a rough phase. Therefore, against the expectation of raising Rs 1,000 crore, the fund could manage only one-tenth of that. However, since then the fund has seen a continuous rise in its AUM and at the end of the May 31, 2015 its net assets stood at Rs 1,128.5 crore. The increase in the AUM has been backed by the superior performance of the fund that has consistently outperformed its category and benchmark. In the trailing three-year period ending June 22, 2015, the fund has beaten its category return by 445 basis points while in the last seven years it has outperformed its category by almost 600 basis points CAGR.

Even if we take into account the yearly performance of the fund i.e. the calendar year, we find that it has each time outperformed both its benchmark as well as category returns. This applies to both a falling market like 2011 and the rising markets of 2009 and 2014. It’s not that a few bouts of quarterly outperformance have helped the fund to achieve this feat. Analysing the outperformance of the fund compared to its benchmark on a month-on-month basis, it shows that it has remained in top quintile in its category.

Such performance is backed by better allocation of funds among sectors and right stock-picking. If we analyse the portfolio of the fund for the last two years we find that most of the alpha is generated by right stock selection. When it comes to this factor, the fund manager normally applies a bottoms-up approach for stock-picking and selling the stock if it has significantly breached the value gap from a long-term perspective. With regard to the sectors the fund seeks to invest in those where the opportunity size is large so that the growth potential is decent. The investment strategy of the fund is to have a diversified portfolio with no bias towards a particular theme, sector, market-cap or style.

Currently the portfolio of the fund is more inclined towards large-cap stocks that account for 66 per cent of the entire portfolio. Mid-cap and small-cap stocks constitute 33 per cent of its portfolio. Financial (29.12 per cent), technology (9.43 per cent) and healthcare (9.13 per cent) are the top three sectors where the fund has parked its money. The fund is suited for every investor and could form the core of your portfolio.
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BIRLA SUN LIFE INDIA GEN NEXT FUND

What really differentiate India from other developing nations is its demographic dividend and the fact that it is still predominantly a consumption-led economy. And this thematic fund from Birla Sun Life MF wants to leverage this unique position of the Indian economy to provide better returns to its investors.

Birla Sun Life India GenNext Fund aims to invest in equity of those companies that are expected to benefit from the rising consumption pattern in India, which in turn is getting fuelled by high disposable incomes of the young generation (Generation Next). These companies should be engaged in manufacturing of products or rendering of services that caters to this particular age group.

This is reflected in the constituents of the portfolio of the fund, where financials, FMCG and automobile dominate the fund. At the end of May 2015, financials shared 30.43 per cent of the total fund; it is lower than what its benchmark CNX Nifty with 31.41 per cent. Nonetheless, FMCG is contributing 23.54 per cent of its total portfolio against CNX Nifty having 8.19 per cent. The other important consumer cyclicals like automobile forms 11.56 per cent of the total portfolio. Sectors like information technology (IT), which forms a large part of many funds, are conspicuous by their absence in the top 10 sectors. Historically, the fund has been overweight on consumer cyclical and financial services that formed more than 50 per cent of the portfolio.

This sectoral allocation has worked for the fund in over a long term period; however, this fund is better able to navigate through the downturns of the equity market. For example, when the equity market gave a negative return in the years 2008 and 2011, this fund was able to arrest its losses. In 2008 when Nifty fell by 52 per cent, the fund was down by 48 per cent. Even in 2011, when the Nifty was down by 25 per cent, the fund managed to arrest its decline to 14.5 per cent. In the last three years the fund has generated a return of 29.42 per cent against 21 per cent of its category.

We believe one should add this fund to add stability to one’s portfolio as the scheme allocates funds to sectors that are primarily consumption-driven and largely remain less volatile than the overall market. This makes the fund a king of bad times. Therefore we recommend this scheme to those conservative investors who can sacrifice a little extra return for the want of stability in returns.
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SBI MAGNUM MULTICAP FUND

It is a foregone conclusion that the equity market is full of uncertainty and different types of stocks and styles lead the market in different times. Therefore, a multi-cap fund, which invests in all styles and capitalization sizes, can target a wider range of opportunities and have the potential to deliver strong performance on a consistent basis across a long time horizon.

SBI Magnum Multicap is one of such funds that has outperformed its category consistently in the long term. In the trailing three years the fund has given annualised return of 27.1 per cent compared to category return of 23 per cent. Even for a smaller time frame of the last three months ending June 22, the fund has given return of 1.44 per cent against a negative return of 0.18 per cent by category. The consistency of the returns is also reflected by the number of months the fund has beaten its benchmark index i.e. S&P BSE 200. In the last three months, almost 64 per cent of the time the fund has been able to beat its benchmark index.

The figure on a quarterly basis is much improved and for the 13 quarters ending March 2015 this stood at 84 per cent. Delving deep into the fund’s analysis, it shows that right stock selection has played a major role in beating the category and benchmark returns. In the last two years the fund has selected the right stock 64 per cent of the time. Such remarkable returns are generated by the fund by taking limited risk. The volatility of the fund returns, gauged by standard deviation, stood at 12.7 per cent compared to 15 per cent for the benchmark. The Sharpe ratio for the fund stood at 1.7 compared to 1.12 for the benchmark index.

One of the factors that help multi-cap funds to perform consistently is their flexibility to change their portfolio concentration depending on market conditions. If the markets are in a bullish phase or the earnings cycle is in an uptrend, they can increase the allocation to mid and small-cap stocks and cut their exposure to large-cap. The latest portfolio clearly shows that the current focus of the fund is more towards the mid, small and tiny-cap stocks, which constitute almost 52 per cent of the portfolio, while large-cap stocks form 48 per cent of the portfolio. In terms of sectors, the financial sector stocks dominate the portfolio with 24.43 per cent of the total portfolio followed by FMCG and construction forming 10.28 per cent and 9.68 per cent of the portfolio.  We advise limited exposure to this fund to moderate risk-takers.