DSIJ Mindshare

Top 7 Must Have Mutual Funds

EQUITY MARKET OUTLOOK 

Investors enthused by the current rally in the equity markets in India, will be keenly looking at FY18, as the year promises to be full of action. The benchmark index, Sensex, is up by an impressive 12 per cent on a YTD basis (as on April 18), and is the best performing equity market globally in dollar terms. In dollar terms ,Sensex has clocked 18 per cent returns on a YTD basis.

The most important question that investors will be asking is whether the impressive rally will continue, and which sectors will continue to lead the markets.Previous one year has seen broad based participation from all the sectors, and majority of the sectors have done well, with an exception of IT, Healthcare and Power sectors.

The market value for Indian equities stands at $ 1.91 trillion by end of January 2017 , also the highest since January 2008 , which suggests nearing of market cap to GDP ratio to almost 100 per cent. The market cap to GDP ratio for Indian equities in December 2007 was almost 140 per cent. The data hints at further possibility of markets heading northwards.

However, it is doubtful if such valuations may be sustained, and it looks like majority of the positives are fully reflected in current prices. The Indian markets are currently trading 17 times to its projected earnings, which is a good 20 odd per cent premium to long-term average. What is interesting to note here is that barring Technology and Healthcare stocks in the benchmark index — Nifty , nearly all of the index constituents are reflecting rich valuations, higher than their long-term average.

For short term investors, valuation remains a concern with markets rising sharply over past one year. The MSCI India index is trading at 19 times its trailing 12- month earnings, which suggests a heavy premium to its emerging market index, MSCI, emerging market index. MSCI emerging market index is trading at nearly a multiple of 15 as on March 31, 2017, and is up by 11.19 per cent in 2017 till March 2017. This suggests that Indian equity is overvalued both on absolute basis as well as on relative basis.

KEY TRIGGERS FOR THE MARKETS

Having discussed the valuation concern, the script is extremely positive for the Indian equities, and probability is high that equity as an asset class may outperform other asset classes. Come July and markets will start discounting the GST impact, and also the monsoon impact on the markets.

How efficiently will the GST be implemented is what will interest the markets.

Monsoon factor will come into play come July, and may add to the market volatility. Even though the forecast is for near-normal monsoon, any deficient rainfall may trigger inflationary pressures. RBI, while shifting its stance from expansionary to neutral has outlined monsoon out-turn as one of the key upside risks to inflation.

US FED & QUANTITATIVE TIGHTENING 

The global markets will be keenly eyeing the development is the US markets, and how exactly FED goes ahead with reducing its balance sheet. Post aggressive quantitative easing over several years, the world's central banks are now starting to plan staggered quantitative tightening. It will be crucial for global markets how the Federal Reserve, European central bank and eventually the Bank of Japan manage the oversized balance sheet, and whether the interest rate will stiffen in the process. The assets have at-least doubled since 2008 at all the said central banks owing to the quantitative easing programme. Put together the balance sheets of the three central banks add upto almost $ 13 trillion.

EARNINGS

Markets can expect to take comfort from the visible earnings uptick this season, however, much of the earnings upgrade seems to be already priced in. Markets will need confirmation on the reforms front along with earnings growth to inch higher from current levels to make record highs in FY18.
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CASH HELD BY MFs 

The cash levels held by the equity mutual funds climbed to an average 6 per cent of total assets for the March quarter, and that's the biggest proportion since 2012.

Such high levels of cash held with the mutual funds indicates that any correction in the stocks might get bought into, which means there will be a limited downside to the markets.

However one must recall that the average cash proportion held during the global financial crisis in 2008 was 13 per cent; whereas, the peak reading stood at 20 per cent in February, 2009.

MUTUAL FUND INFLOWS

Mutual Funds are witnessing a steady inflow of funds into almost all of its categories.

The Indian MFs received a little over Rs.2 lakh crore since May 2014, reflecting on an average monthly inflow of around Rs.6,100 crore during the said period. Investors across the country have shown a preference for investing in markets via systematic investment plans (SIPs). SIPs alone have amounted to almost Rs.4,000 crore per month, which can be considered a quite healthy inflow. The best part of increasing SIP investments in mutual funds is that the funds tend to be sticky, and thus provide a cushion for markets.

SIPs have contributed approximately 43% to the total equity inflows in the past six months, which is quite healthy. With a healthy growth seen in SIP investments, we may see close to $ 1bn of SIP based money inflow into mutual funds in the foreseeable future.

It is observed that 28 per cent of the inflows in the equity funds is from balanced funds for the last fiscal.

Balanced funds' popularity is increasing owing to the increased volatality in the markets. Out of Rs.1.30 lakh crore of net inflows in equity category, almost Rs.36,610 crore flowed into balanced funds in FY2016-17.

It is seen over the years that the money flows into the markets when the markets surge higher, indicating a close linear relationship between money inflows and short-term market returns. It will be wise for investors not to look at money flow into equities as a lead indicator for Indian markets, as the flows follow returns rather than the other way round.

One of the important aspect that affects the inflows into mutual funds is prevailing interest rate, and outlook in future, clubbed with expected returns on alternative asset classes. Current scenario suggests no other other class looks promising enough, and hence equity as an asset class will remain in focus.

RETAIL GROWTH 

Ever since Modi took office in May 2014, individual investors have been major contributors to the mutual fund growth story in India.

For the fiscal year ended March, the retail accounts in equitylinked plans grew by 5.8 million to 44 million in the fiscal ended March, as per the data from Association of Mutual Funds in India (AMFI). Investors pumped in Rs.70,400 crore into equity funds since 2014, also recording a third straight year of inflows into the markets. With fresh money and buoyant market, the assets managed by the equity fund reached its all-time high of Rs.5.47 lac crore at the end of March, up from about Rs.4 lac crore, a year back.

LARGE -CAP MFs VS MID/SMALL-CAP MFs

Mid-cap and Small-cap stocks have been outperforming the benchmark indices by a good margin for several years now. Mutual Fund investors who have shown conviction in the mid-cap space, and have a higher risk appetite, benefited from their investments in mutual funds that primarily invest in mid and smallcap stocks.

Clearly as a category, the Mid and Small-cap oriented mutual funds have outperformed the mutual funds that invest primarily in large cap stocks:

When we look at the mid-cap stocks in India, and compare it with its global peers we find that the Mid-caps in India are trading at a lower multiple to mid-caps in USA, as represented by MSCI USA Mid-cap Index. The MSCI World Mid-cap index is trading at a PE multiple of 23.44, higher when compared to the multiple for the MSCI India Mid-cap Index (INR) at 22.76. This suggests that the mid-cap valuation may not have stretched to untenable levels.

Investors looking to take fresh exposure may opt to invest in small and mid cap funds via the SIP route, taking into consideration the volatile nature of funds return.

CONCLUSION 

Mutual funds being a critical, and mostly inescapable feature of an individual's investment planning, opting for the right mutual fund scheme becomes the most decisive factor of a sound investment decision. A comprehensive study of all the aspects of the fund, including the fund manager credentials, assets under management, historical track record, expense ratio, among others is an essential facet of making the investment.

While wealth creation opportunities are rife with higher growth characteristics of Indian mutual funds, choosing the right mutual fund from thousands of schemes available in the market emerge as the biggest hassle for investors trying to encash the opportunity. At present, Indian mutual funds are consistently outperforming industry averages with generous alpha or excess returns. However, with stretched valuation and concern over the fed's quantitative tightening, it may be difficult for benchmark indices to clock returns higher than 10 per cent in the coming year.

Mutual Fund investors need to create a portfolio of mutual fund schemes that will not only help diversify and reduce risk, but will also allow tapping varied opportunities that may present themselves in the forthcoming years.

As the environment promises to be volatile in the first half of FY18, such market environment can be used to consolidate investments, and continue accumulating mutual fund units for the top mutual fund schemes selected. Systematic Investment Plan (SIP) works best when markets are choppy. SIP will be highly recommended for those funds that primarily invest in mid-caps and small-caps. Long term bullish sentiment is intact, and good amount of money flow is expected into equity mutual fund schemes. Hence, mutual fund investors do not have a major reason to worry as such. However, the expected returns from equity markets in FY18 may not be exciting to say the least.

With markets expected to trade range bound, and in a consolidation phase in near term, such a phase in the market can be best utilised for optimum asset allocation, and accumulate with a three to five year perspective.

(With Additional Inputs from Nikita Singh)

Kaustubh Belapurkar, Director of Fund Research, Morningstar

"Large-cap funds will also see robust inflows"

FY17 has been a good year for MFs in terms of investor participation. How do you think FY18 would be?

FY17 was a great year for mutual fund flows. Investors continued to pour money into debt, allocation and equity funds alike. Equity flows continued to be strong through the year, especially in the second half. The most pleasing aspect was that when the markets corrected, unlike the trend from earlier years of outflows, this time around, investors increased allocation to equity funds. This is a sign of increasing maturity of investors. Increasingly, investors used the Systematic Investment Plan (SIP) route to invest, with the monthly SIP figure now standing at ~Rs.4300 crore, as per AMFI. We expect this trend to continue in FY18 and beyond. The SIP book should continue to grow and investors having seen a few market cycles should continue to plough money into the markets, especially during corrections. The effects of demonetisation are also expected to boost flows as investors seek avenues beyond the traditional bastions of real estate and gold. Overall, we expect to continue to see good flows in funds.

Which category of funds witnessed maximum investments in FY17? Which category of funds are expected to do well during the coming year? 

Amongst equity funds, while naturally large cap funds saw the largest absolute inflows, but mid-cap funds and balanced funds continued to receive disproportionate inflows in the year. Many first-time investors choose the less volatile option of balanced funds to enter the equity markets for the first time. Given that the increasing investor awareness is drawing newer investors into the market, we continue to expect balanced funds will get disproportionate inflows. Large-cap funds will also see robust inflows while mid-cap funds flows may see a slowdown given the increasing valuations on these stocks.

What investment strategy should be adopted to maximise wealth via MFs?

We continue to advocate investors to follow a methodical asset allocation approach based on their risk-return objectives and investment time horizon. Given the current high valuations of small and mid-cap stocks, investors can choose to marginally reduce allocation to these funds or wait for market corrections for fresh purchases. SIPs are a good way to go about investing as not only do they mitigate market timing risk, but also instill financial savings discipline. It is also very important to pick funds based on your investment horizon and not be swayed by past performance. Holding discipline is also key, as markets may go through periods of volatility, but as long as you hold onto to your investment for the required period, there is a high probability of meeting your desired investment outcomes.

What is the ideal number of MF schemes one should hold in a MF portfolio? 

An ideal number of schemes in a portfolio should typically never exceed 10 funds. More often than not, this number will suffice to meet your investment requirements, and beyond that, over-diversification may actually be counterproductive. While constructing your investment portfolio, it is paramount you spend ample time choosing the right set of funds to match your risk-return and investment time horizon. Review your investments on an annual basis, but resist the temptation to redeem funds that underperform in the short term, as every manager will go through bouts of relative underperformance. Change your portfolio funds only when there is sustained underperformance, change in fundamental attributes of the fund or change in your own investment objectives.
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Kaushlendra Singh Sengar, Founder & CEO, Advisorymandi.com

"For The Next Six Months, We'll See New Highs Being Made"

How long in your view the mid-cap stocks will continue to outperform the benchmark index? 

The mid-cap index not only trades at a 37 per cent premium to the Sensex, but also at a 19 per cent premium to its five-year average price-to-earnings ratio. Despite the fears from demonetisation and Brexit, state assembly elections, GST Bill, BJP's landslide win in the U.P state election and other global and domestic factors that contributed to the investor's sentiments, the mid-cap companies have managed to outperform the benchmarks Sensex and Nifty.

When we compared the Sensex and Nifty with S&P BSE Mid-cap, the return was just more than double. In one year, where Sensex gave return of 10 per cent and Nifty gave 12 per cent, the mid-cap benchmark gave return of 29 per cent.

Along with premium valuations, the public offers lined up in the market will also put pressure on the financial resources of investors. With demand for initial public offerings at the highest in 11 years, there is a high chance of profit-booking in mid-caps as investors may look to free up their resources. So, mid-cap stocks could end their dream run. We advise investors to take the mutual funds route as mid-cap investing can be more volatile.

For the next six months, we'll see new highs being made, and then we might see a phase of correction.

Will FY18 be another year where Sensex will deliver double digit returns? 

We are expecting a return of 8-10 per cent for Sensex in FY 18. 

The key triggers are: 

a) How well the GST is implemented and how companies react during this period will also have a bearing on corporate earnings. 
b) The monsoon and its impact on inflation is another key event. Already, the initial forecasts suggest the monsoon to be below normal. 
c) At the global level, events such as the outcome of French elections. 
d) Policies adopted by the US president, and oil price trajectory will impact sentiments in FY18. 
e) The only domestic risk factor would be the monsoon. 
f) Seventh Pay Commission expenditure.

Will FIIs continue to invest in Indian equities? In your view, what are the key risks to consider while investing in markets at current juncture? 

Investments by FIIs into Indian equities in March hit highest in about 15 years, even foreign investors will likely continue to be bullish on the Indian markets on the back of the strong domestic fundamentals (BJP's landslide win in the U.P state election). The data released on March 31 2017 showed overseas investors bought a net $8.84 billion (~ Rs.575,000 crore) worth of Indian shares and bonds during March, the biggest monthly total since at least 2002, according to stocks depository services provider NSDL. Equity investments are at a little over half of the aggregate amount.

Tax reforms, fiscal stimulus and economic and trade policies under the Trump administration would be keenly watched by global investors. Any failure in the implementation of tax reforms or move towards protectionism and trade wars would be viewed sentimentally as negative for global equity markets. Indian monsoon expected to be below normal is an another risk to be considered before investing in the market.
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PVK Mohan, Head — Equity, Principal Pnb Asset Management Company

"Equity markets will perform well in FY18 despite volatility"

How do you see equity markets shaping up in the coming year? 

We expect the equity markets to perform well in FY18 on the back of a pick-up in economic growth and corporate earnings growth, and continuing healthy inflows into MFS and FII inflows. We do however see some volatility in the quarters ahead arising due to potential disruptions on the back of GST implementation and valuations running much ahead of actual earnings.

Will equity outperform other asset classes in the coming year? 

We expect equity market returns of 12%-13% in the year ahead and this would be better than returns from debt instruments.

What are the key triggers for the equity markets that one should watch out for? 

The key triggers would be a pick-up in economic growth, better corporate earnings growth, implementation of structural reforms like GST and eNAM (leading to higher farm incomes and lower consumer prices), thrust on infrastructure and big push by the government to invigorate the rural economy.

What are the key risks at this point of time for the equity investors? 

The key risks arise from fears of growing protectionism globally, geopolitical tensions ?globally, rising inflation trend in India, concerns of El Nino emerging after July and short term disruptions to economy due to GST implementation

Ramnath Venkateswaran, Fund Manager-Equity, LIC Mutual Fund

"Transition To GST Will Be Crucial"

In your view, will equity as an asset class outperform in FY18? 

Equity markets have been largely flat over the last two years and there are incipient signs that the underlying economy is gaining strength. It is quite likely that in FY18 equity markets will deliver better tax-adjusted returns than other asset classes. However, it is unlikely to be a broad-based rally in equity markets. The stocks of companies that have been facing headwinds over the past 5 years are likely to perform better as compared to the current favourites.

Mid caps have outperformed Sensex over the past three years. In your view, will the outperformance continue?

Mean reversion is a well-recognized phenomenon in financial markets. History suggests that there has never been a three-year period when mid-caps have delivered higher returns than large caps on a consistent basis. Markets appear to be assuming consistent growth for most mid-cap companies and an overwhelming majority of the mid-cap companies will not be able to transition to the large-cap category, given the challenges of transitioning to a mature company with enduring moat. Hence, there is fairly high probability that mid-cap segment takes a brief pause next year given the valuations, while the large cap segment outperforms.

Which sectors are showing maximum traction in terms of earnings?

Beaten down sectors like PSU banks and metals are likely to lead the earnings upgrade cycle in the current year, given their depressed earnings base of last year.

What are the key risks and triggers for equity markets that one should watch out for?

Progress on resolving the stressed loan problem is a key for reviving the growth cycle. If the government is able to establish a transparent process in arriving at the hair-cuts for some of the unsustainable debt, the business confidence is likely to see a rebound and improve the investment climate.

Transition to the GST regime by companies, tax authorities along with the quantum and spread of monsoons are likely to be the domestic risk factors.

Geopolitical developments like rising tensions in the Middle East and the Korean peninsula, along with the rising nationalist tendencies in western countries are the major risk factors for the markets.

PAST PERFORMANCES

The mutual fund schemes recommended in Dalal Street Investment Journal's (Vol 32 No 2) cover story titled 'Come 2017, invest in these 7 ELSS MFs' (Dec 26, 2016 - Jan 8, 2017 issue) booked impressive returns with gains in two digits, ranging between 12 per cent and 17 per cent for the period between January 8, 2017 and April 18, 2017 (annualised return is 39.58 per cent). While DSP Blackrock Tax Saver Fund was the highest gainer with 17.5 per cent, Franklin India Tax Shield booked the lowest returns in the group with a 12.3 per cent return. Reliance Tax Saver - Growth scheme and Birla Sun Life Tax Relief 96 - Growth scheme gained by 16 per cent each. Invesco India Tax Plan -Direct Plan - Growth scheme gained by 13.8 per cent, Axis Long Term gained 13 per cent and IDBI Equity Advantage - Growth gained 12.8 per cent. Sensex during the same period has gone up by 9.70 per cent.

This goes to show the importance of selecting a good mutual fund that can outperform the benchmark.

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