MF Query Board

Readers are requested to send only one query at a time so that more readers get a chance. Have questions relating to any aspect of personal finance. Ask DSIJ at editorial@DSIJ.in and get your queries resolved.

I have invested in Franklin India Smaller Companies Fund and Franklin India Focused Equity fund which have not been performing up to the mark for the last several quarters. What should be my course of action?

- Meenakshi Gaur

Both Franklin India Smaller Companies Fund and Franklin India Focused Equity Fund are risky funds. Let us first begin with Franklin India Smaller Companies Fund which is a small-cap dedicated fund and had invested 73 per cent of its assets in small-cap companies at the end of June 2020. You have rightly pointed out that it is underperforming on a quarterly basis. Further, even on an annual basis it is underperforming the benchmark as well as the category since 2017.

This can be attributed to two back-to-back exits of fund managers since 2017, which might have impacted the fund’s performance. This fund is overweight on cyclical and sensitive stocks from basic material and industrial sectors. This makes the fund more vulnerable to volatility. On the sectoral front, it is heavyweight on financials and consumer durables as compared to the category.

Looking at its trailing returns, it has underperformed its benchmark as well as its category across different periods. To further delve on its returns, let us have a look at its rolling returns.

The three-year rolling returns tells a different story altogether. As per the available data, it is beating its benchmark. However, purely in terms of risk statistics for the last one year, the fund is more volatile than its category average. Hence, it is better to switch to other funds which have done better than Franklin India Smaller Companies Fund in the same period.

Now let’s talk about Franklin India Focused Equity Fund. This is a focused multi-cap fund wherein it is heavily invested in large-cap stocks with 76 per cent of the assets dedicated to large-caps followed by 13 per cent in mid-caps and 11 per cent in small-caps. And being a focused fund, it does carry concentration risk. Presently, it invests precisely in 27 companies with 64.81 per cent in top 10 companies.

This means that the top ten holdings would drive the returns of the fund. Further, the sectors that it is betting on would not be in favour in the near future. However, if your investment horizon is more than five years then it can give good returns. But there are similar funds in the category which have provided better returns consistently as compared to Franklin India Focused Equity Fund. Our suggested course of action for both the funds is that you should sell and invest in a better fund within the category.

I have been investing in a mutual fund for the past four years. Though I know the technical meaning of compounding, I would like you to explain with a case study. Also, after how many years can I reap the real benefits of compounding and will AMCs allocate additional units from my unrealised profits?

- Dhayanandh

Compounding effect has great power to create wealth. Let us understand this with the help of an illustration. Let’s say there are two friends, Ramesh Shah and Dinesh Munot. Both of them have invested Rs 1 lakh each in an investment avenue providing 12 per cent rate of interest for 10 years. However, Shah did not reinvest the interest earned. On the contrary, Munot reinvested his interest.

As we can see, though initially Munot’s investment was lagging behind Shah’s investment, after five years Munot’s investment outperformed Shah’s investment. This is because Munot earned interest on interest as well whereas Shah earned interest only on his principal amount. If we look at the total value after 10 years, with both investing Rs 1 lakh, Shah accumulated Rs 2.2 lakhs while Munot accumulated Rs 3.11 lakhs. And to answer your question as to how many years it takes to reap the real benefits of compounding, there is no fix thumb rule to this. But yes, it takes quite a long time to reap the benefits. Hence, starting early and remaining invested for long-term is essential.

To answer your second query, asset management companies (AMCs) don’t allocate units from your unrealised gains. AMCs would only allocate units when you make a purchase request. Hence, if you wish to get units from unrealised gains, you first need to realise your gains and then make a purchase request to the AMC. However, we would recommend not doing so as it would defy the whole purpose of remaining invested.

Readers are requested to send only one query at a time so that more readers get a chance. Have questions relating to any aspect of personal finance. Ask DSIJ at editorial@DSIJ.in and get your queries resolved.