8 Best MF Schemes

A lot has changed both regulatory and otherwise, since we recommended the best equity diversified mutual fund schemes to our readers last year. Market regulator, Securities and Exchange Board of India (SEBI) recently announced many changes to revive the mutual fund industry (See on following page: Sweeping Changes). However, at this point of time it will be fairly premature to analyse how these changes will really impact the industry. But prima facie, the SEBI seems to have played a role of a market developer and the changes it has proposed will incentivise the Asset Management Company's (AMC) to increase the retail participation and reach out to investors beyond the top 15 cities that currently are contributing to only 13 per cent of the total assets under management (AUMs). As of now, 45 per cent of the total AUMs come from a single city (Mumbai) and the rest of the top 14 cities account for another 42 per cent of the total AUMs.

The Mutual Fund industry has been badly hit over the past couple of years. The impact of this is clearly exemplified by the exit of one of the largest AMCs in the world; Fidelity, from the Indian market after having solid its operation to L&T Finance. If media reports are to be believed, there are other players too that are willing to exit the business. The immediate reason for such action is the worsening financial performance of the AMCs. For FY12 the top nine AMCs (excluding Franklin Templeton, which follow an October - September year ending pattern for its financial results) have recorded a combined profit growth of just around five per cent. It was majorly an inflow from the fixed income part that saved the day for these AMCs. Had it not been for those inflows, the performance would have been even worse.[PAGE BREAK]

The reason for such a show is not unknown; the blame squarely lies on the continued ban on entry loads that left distributors with no worthwhile reason to hard sell MF schemes. What followed were declining AUMs. For FY12, the AUMs of equity schemes remained almost flat with a marginal increase of just around 0.06 per cent. However, on a year till date basis (April-August 2012), the situation looks even gloomier with equity schemes (excluding ELSS) having seen a net outflow of Rs 3035.86 crore.

It is not only the regulatory changes that have taken the sheen out of the Mutual Fund industry. The volatile and falling equity market is also equally responsible for the current state of the industry. It is a long known fact that AUMs of the industry move in tandem with the equity market and are positively correlated. For calendar year CY11, the broader equity market declined by 25 per cent and during FY12, the market was down by 11 per cent. Therefore, it was a combination of both regulatory changes and the not so good equity markets that led to such a precarious condition of the industry.

Sweeping Changes

• Self-regulatory organisation (SRO) for distributors to be formed.
• SEBI to regulate advisors who charge a fee.
• Advisor regulations announced.
• Fungibility allowed in total expense ratio (TER).
• 30 basis points extra spend for applications received beyond top 15 cities.
• Exit load to be credited to the scheme.
• Service tax to be charged to investors.
• SEBI board to make recommendations to allow equity schemes under the Rajiv Gandhi Equity Savings Scheme (RGESS).
• Higher disclosure requirements from AMCs - fund inflow data, new product labelling mechanism.
• SEBI Committee to formulate an MF policy in six months to look at tax treatment, other products, AMC obligations.[PAGE BREAK]

Looking Beyond

Not everything is as bad as it looks on the surface of it. In our analysis of 173 equity diversified funds, we found that a good 73 per cent of the funds were able to beat their benchmarks for three-year period ending September 26th, 2012. Even when we compared their performance with the broader market indices like the BSE Sensex we found that a good 60 per cent of them were able to outperform these indices as well over the same period. Nevertheless, in the last one year the situation has deteriorated. Yet, 56 per cent of the funds were able to beat their own benchmarks but when we compare returns provided by these funds with those of the broader market over the same period, a whopping 96 per cent of them seem to have failed to meet the broader market returns.

This, we believe, is exactly the reason for the apathy of investors towards equity schemes. Investors’ have seen the value of their investments dwindle as compared to the broader market. But there are two points that investor need to understand. First, though investors have lost money in the last one year by investing in these schemes, they would have suffered more losses had they invested directly in the equity market compared to investing in well performing mutual fund schemes. Second, as we have always said, investments in equity should be done with a long term horizon in mind and we have seen that over a long term (three-year performance) good funds have performed better than the broader market.

So, as general wisdom goes, invest for the long term in equity markets, and, the best mode for retail investors for doing so would be mutual fund schemes that take away most of the hassles including researching the market from your head onto theirs. After being range-bound for the past few quarters, the broader equity market has again started moving up and this makes it the right time to invest in these schemes. To help you make the right choices we are recommending eight mutual fund schemes selected after a thorough analysis of their performance and other critical factors. We recommend that you invest with a time horizon of two to three years which should help you garner better returns going forward. We recommend that retail investors invest through SIPs as they help you even out the short term volatilities of the market.[PAGE BREAK]

Review Of Last Year’s Rs 10 Lakh MF Portfolio Recommendation

Without being too modest, we would rather be proud about how right we were with our mutual fund analysis last year. The MF fund schemes picked up by us last year have yielded superlative returns as compared to the broader market. While the Sensex has generated a return of just about six per cent since October 2011 till date, our recommended portfolio has returned a good 15 per cent over the same time period. The best performance was that of the Reliance Equity Opportunities Fund. It yielded a return of 20 per cent followed by the SBI Magnum Emerging Business Fund that generated 19 per cent returns. All of our recommendations have given higher returns than the average return generated by the equity diversified funds (8.13 per cent) as a category during the same period.

Methodology

To start with, we took the entire universe of equity diversified funds. We then applied various filters to narrow down our search to the eight best mutual fund schemes. The first such filter that we applied was the period of existence of the funds. We have considered only those funds that have been in the circuit for more than three years, and whose corpus is more than Rs 75 crore. We considered a trailing three-year time frame because this period gives us the opportunity to judge the performance of a fund in different phases of the market. This would include the bull run of 2009-10, the consolidation phase of 2010-11, as well as the declining phase of 2011-12. Analysing the performance in these time periods gives a clear idea about the resilience of the fund.

Next, we ranked the schemes based on their performance in four time periods – one month, six months, one year and three years. These ranks were then given a weightage, with 50 per cent weightage given to the three-year rank, 30 per cent to the one-year rank and 10 per cent weightage each to the six-month rank and one-month rank respectively. The logic for this weightage was to give more importance to those funds that have performed well consistently over the long term. After this, we examined a few ratios such as the Sharpe ratio, expense ratio, as well as the orientation of the fund, which gives an idea of where a large chunk of the funds have been invested.

We further considered certain softer issues, such as the performance of other funds being managed by the same fund manager, to know if there is any aberration. In the interest of proper diversification, we selected only one fund from each fund house. This is how we arrived at the eight best fund schemes that have not only performed well in the past, but which are expected to perform better in these trying times too.[PAGE BREAK]

From a gamut of fund schemes that are presently being offered to investors, here are the eight best which ought to be a part of your portfolio...

Birla Sun Life India GenNext
NAV - Rs 28.81

A major differentiator between India and other major emerging economies is that it is predominantly a consumption led economy. And this 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 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 go directly to the consumer and their products and services should have a distinct brand identity.

This is reflected in the portfolio of the fund where as at the end of August, 2012 we see FMCG dominating the overall scene with a weightage of 26.85 per cent, followed by Financials and Healthcare with a weightage of 19.95 and 16.59 per cent respectively. Some other sectors like Information Technology (IT) are conspicuous by their absence.

This sectoral allocation has perfectly worked for the fund and is reflected in its performance where it has constantly remained one of the top performers in its category over the last few years. In the last three years the fund has generated a return of 15.26 per cent against 4.2 per cent of its category. The best performance came in the last one year when it beat its category by a whopping 12.86 per cent and the Nifty by 7.16 per cent.

We believe, one should add this fund to add stability to one’s portfolio. As the scheme allocates fund 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 as is reflected in its performance in the year 2008 and 2011 when the things were not so smooth for the equity market. 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. Therefore we recommend this scheme to those conservative investors who can sacrifice a little extra return for the want of stability in returns.

Canara Robeco Equity Diversified
NAV - Rs 60.24

Following predominantly a blend of top-down and bottom-up approach the fund has been able to garner better returns for its investors over a period of time. The investment decision is dependent on three factors a) it invests in companies with robust business fundamentals, b) proven management capabilities and c) which are available at reasonable valuations. The fund has seen a leadership change only in the month of September 2012 with Ravi Gopal Krishnan taking the baton from Ritesh Jain and Soumendra Nath Lahiri. As of June 30, 2012 the fund had an AUM of Rs 622 crore. “As per our strategy, we avoid getting swayed by market movements. Instead we follow a disciplined approach of sticking to fundamentals and fair valuation of stocks. This drives our selection process.” says Ritesh Jain, When asked about his success mantra, this is indeed a good one looking at the outperformance by the fund as compared to its peers as well as its benchmark index.

Since inception the fund has garnered a return of 21.87 per cent. If we look at the 3-year performance we find that the fund has outperformed its category by 515 basis points and the return stands at 11.05 per cent.

The top five sectors constitute around 66.36 per cent of the holdings. The top ten holdings constitute of 41.47 per cent of the portfolio. The fund has a very low turnover ratio of 0.44x which suggests that it also follows a buy and hold strategy which has worked as a value accretive for the fund.

With a focus on the large and mid cap stocks the fund has given more importance to the large cap stocks which constitute around 76.39 per cent of the portfolio while mid and small cap stocks constitutes 18.76 per cent and 4.86 per cent respectively. It is this track record and the expertise of the fund house which gives us conviction in recommending this fund to our readers.

ICICI Prudential Focused Bluechip Equity
NAV - Rs 17.60

With net assets of around Rs 3841 crore at the end of June 30, 2012, ICICI Prudential Focused Bluechip Equity Fund is one of its kind that has been able remain an outperformer at all the times. Managed by Manish Gunwani, the fund has tackled all the trying times with ease. Large cap stocks consist of around 91.45 per cent of its net assets while the rest 8.55 per cent consist of mid-cap stocks. As is clear from the portfolio concentration, it focuses mainly on large cap stocks which are built via the bottom up stock picking process.

The fund is a believer of the ‘buy and hold’ strategy and has a relatively lower churning as compared to other funds in the category. According to Manish Gunwani, “the fund follows a bottom up stock selection strategy with the objective of outperforming the benchmark and generating an alpha from being overweight on certain high conviction stock picks.”

Launched in May 2008 when equity markets across the globe were falling, the fund manager was in no tearing hurry to deploy cash and the debt exposure averaged close to 30 per cent for the first five initial months of its launch. The portfolio had an exposure of around 16 per cent to derivatives between July and December of 2008. Yet, its performance in September 2008 was surprisingly almost equal to the fall of the category average though it managed to stem the slide better in the December quarter. By the time the market began to rally in March 2009, the fund held close to 91 per cent of its assets in equities (including equity derivatives). After that, there has been no looking back.

The fund has featured in our list consistently for the second consecutive year now. Backed by its strong performance it has actually acted as a value accretive proposition in one's portfolio. It has outperformed its category of funds by 614 basis points which can be a cause of envy for peer fund managers. Since inception it has given a return of 13.62 per cent. The top five sectors constitute around 75 per cent of the holdings. The top ten holdings constitute 57 per cent of the portfolio. One change has been that the number of stocks has been increasing from around 22 to 30 aligned to the size of the fund. Keeping in mind that the fund has allocated 91 per cent towards large cap stocks there will be no problem of liquidation. We suggest our readers add this scheme to their portfolio from a longer term perspective.

Kotak Mid-Cap
NAV - Rs 27.57

Launched in the year 2005, Kotak Mid-Cap has seen the major bull and the bear phases of the market. But, the fund has been an outperformer which is substantiated with the fact that it has been able to generate 14.16 per cent return since its launch. Managed jointly by Pankaj Tibrewal and Emmanuel Elango, it aims to generate capital appreciation from a diversified portfolio of equity and equity related securities. It predominantly invests in midcap stocks whose market capitalisation lie between Rs 150 crore and Rs 1500 crore. The average AUM of the fund as of June 30, 2011 stands at Rs 268.8 crore.

Pankaj Tibrewal attributes the success to the strategy that the fund follows. “We have been consistent in our approach of managing the fund through the basic principles of diversity and discipline. We have been following a combination of the top-down and the bottom-up stock picking strategy in managing the fund; with a close focus on the benchmark (CNX Midcap) in terms of composition and constituents of various sectors.” says Tibrewal. In addition to this the fund also lays adequate emphasis on additional parameters like leadership position of the company in the sector, capital efficiency and cash flow characteristics to select stocks.

On a three-year basis, the fund has outperformed its category of funds by 215 basis points and the return stands at 11.29 per cent. Tibrewal says “the bottom up stock-picking strategy and the diversification of the portfolio has helped the fund in delivering consistent returns over the last few years.” The year to date returns stand at 32.84 per cent which outperforms its category returns over the same period by 457 basis points.

The top five sectors constitutes around 56.20 per cent of the holding. The top ten holdings constitute 31.23 per cent of the portfolio. With focus on the mid and small-cap stocks the fund has given more importance to the mid-cap stocks which constitutes 65.86 per cent of the portfolio while small caps constitute 26.21 per cent. We suggest, our readers look at this scheme and add it to their portfolio for a longer term benefits.

Mirae Asset India Opportunies
NAV - Rs 17.77

The fund was launched in April 2008 and it was expected to collect around Rs 1000 crore. However, it could manage only one-tenth of that due to the worsening stock market conditions. But since then, the fund has seen a continuous rise in its asset under management and as of June 30, 2012 its net assets stood at Rs 235 crore thanks to a CAGR of around 33 per cent. Focusing on large and mid-cap stocks the portfolio is diversified with large caps constituting 70.29 per cent and mid-caps around 22.17 per cent of the net assets. Smallcaps constitute a miniscule 7.55 per cent of the total net assets of the fund. Managed jointly by Gopal Agrawal and Neelesh Surana the fund has outperformed its benchmark; the BSE 200 Index by around 10 per cent over the last four to five years.

In the three-year period it beat its category returns by 601 basis points. Even if we take the yearly performance of the fund, we find that it has outperformed both its benchmark as well as category returns every time.

How does it manage such a feat? A better allocation of funds among sectors and right stock picking is the key to its success. According to Neelesh Surana, “being in the right stocks at an overall levels (as there were mistakes too) has had helped generate the outperformance. In the last four years, we have to an extent avoided names in infrastructure or real estate, which have been going through challenging times. Along with this, our overweight position in private banks, consumer and the pharma sectors has helped the portfolio, especially in 2011”.

While talking of strategy Surana opines that “they continue to avoid weak business models where cash generation is feeble, and also high valuations.” The fund allocation suggests that the top five sectors comprise around 63 per cent of the total assets. These include Financials, Energy, Technology, Healthcare and Automobiles. With around 70 per cent in large caps the fund does not face any liquidity concerns. Given the fund allocation towards multi-cap stocks and its superior performance, we suggest our readers look at the fund from a longer term perspective.

Quantum Long Term Equity
NAV - Rs 24.19

All intelligent investing is value investing, acquiring more that you are paying for” said Charlie Munger, Vice-Chairman of Berkshire Hathaway Corporation. And this is exactly the intelligent philosophy on which Quantum Long Term Equity is operating and generating an alpha for its investors. “Our performance is mainly attributed to the disciplined investment approach where we buy stocks where we find value and sell them when they are overpriced” explains Atul Kumar, Fund Manager, Quantum Long Term Equity Fund, when asked about the strategy behind the fund’s outperformance.

In the last three years the fund has been able to generate an annualized return of 12.8 per cent against the category return of 5.9 per cent. Even for a shorter duration of the past one year, the fund has been able to beat its category by 6 per cent.

The fund largely maintains a bottom-up and value based approach for selecting any stock and each stock is looked upon for its merit, and then the rest of the things follow. This has helped the fund to outperform the market in both declining phases like that of 2008 as well as during periods of rising markets like that of 2009 where it beat the Nifty by five per cent and 28 per cent respectively. “During the start of the year 2008 we did not find much value in the market and even the stocks that we were invested in were not momentum stocks that were making new highs daily. We tried to stay away from those types of stocks. Similarly in 2009, when most of the players were cautious and sitting on large cash level, we could see a lot of value at that point of time”, says Atul Kumar. The fund does not have any sectoral or market capatalisation bias and the only strict criterion, apart from valuation, that it follows is that the average daily trading volume (including NSE and BSE) of the stock should be atleast million dollars or approximately Rs 5 crore.

Going forward, we believe this scheme is suited to those conservative investors who are interested in building a value-based liquid portfolio and have an investment horizon of more than two years. The fund very skillfully skips momentum stocks that might spur the returns in a shorter term. However, over the long term, the fund will be able generate decent returns for its investors.

Reliance Equity Opportunities
NAV - Rs 41.43

The Reliance Equity Opportunities Fund is one of the top three performers in its category in the one year and three year periods. The fund has been able to beat its benchmark and category by a huge margin during these periods. Had someone invested Rs 10000 into the fund three years back, the value of that investment would have now been Rs 16000 compared to Rs 11164 that would have been generated by investing in its benchmark the BSE 100 Index. Even in last one year the fund was able to comfortably beat its benchmark by 9.12 per cent.

Despite the fund being categorized under the mid and small-cap category and 60 per cent of the stocks held by it being either mid or small-caps that are supposed to be more volatile its Sharpe Ratio is 0.64 (higher the ratio better the risk adjusted performance). This shows that returns are not generated by taking unwarranted risk and that investors are appropriately rewarded for the quantum of risk that is assumed. The investment style followed by the fund has been largely a top-down approach. Betting big on sectors or themes that are currently the flavor of the market, its portfolio is also balanced by way of taking appropriate exposure (10-15 per cent of the AUM) to value stocks. All the stocks before finding its place in the portfolio are thoroughly researched with more importance given to companies with a healthy and rising return on equity.

In terms of the sector allocation, although software and pharmaceuticals hold the top two positions, banking is also witnessing some rise in exposure over the last seven months. Its exposure to banking increased from 8.55 per cent at the end of January 2012 to 11.09 per cent at the end of August 2012.

Looking at the fund’s long term performance and its characteristics, we are convinced of its ability to generate respectable returns for its investors. However, investment in new themes on certain occasions may backfire or might take some time before it yields the desired results. Currently it is the third largest mid and small-cap fund and increase in the asset size might pose a challenge to repeat its past performance. Hence this fund is an advisable investment option for only those investors who have the stomach to withstand volatility and are constantly monitoring their investments.

SBI Magnum Emerging Businesses
NAV - Rs 52.75

With an average of Rs 588 crore in assets under management (AUM) as of June 30, 2012, SBI Magnum Emerging Businesses Fund (EBF) has been a trend setter in its category. Managed by R Srinivasan, this fund has found its place in our list for the second consecutive year. Its total AUM has witnessed a growth of 37 per cent since September last year. The fund is a multi-cap fund that basically has three risk characteristics. One, it is benchmark agnostic, which tends to lend it a higher volatility relative to its benchmark; the BSE 500 index.  Secondly, it has a fairly concentrated portfolio focused on high conviction ideas, and has no market-cap bias but has tended to be skewed towards mid and small caps. Lastly, because of the second factor, liquidity risks are technically higher and investment is made from a three-year perspective.

Managed by R Srinivasan, the fund has returned an annualized 13.24 per cent since inception and its three-year returns stand at 21.43 per cent as against the category returns of 11.42 per cent. How has the fund managed to find a place among our top picks? According to R Srinivasan, “the philosophy of the fund is that it tries to focus on absolute returns for a substantial portion of the portfolio. So, I guess the fact that markets have been range bound (at least in 2010 and 2011) has probably helped in terms of relative returns. Also, and needless to say, our analyst team has done a wonderful job on stock selection”.

What has aided the fund’s performance is the allocation to the relatively smaller stocks as compared to its peers. The fund’s weighted average market capitalisation of around Rs 1600 crore is the sixth lowest in its category. To avoid liquidity issues, Srinivasan ensures that around one fifth of the portfolio is allocated to large caps or cash (though cash levels are restricted to 10 per cent). The top five sectors constitute more than 54 per cent of the net assets of the fund. In the last three years the fund has beaten its category by a whopping 1229 basis points. In the last one year the fund as compared to its category has remained in the positive zone with a return of 17.57 per cent as against a 11.42 per cent return by its category. It is quite clear that the fund has been able to create wealth for its holders over the longer term. We are of the opinion that going forward too it is likely to perform better and has a very good growth potential.

While this cover story advises you on the eight best mutual fund schemes to invest in, we are following this up with our regular ‘Mutual Funds Corner’ section. Do read on to find out what our guest columnist Mehrab Irani, General Manager – Investments, Tata Investment Corporation, has to say on how to pick the best mutual funds, as well as our other regular features including the MF Data Bank.