Earn Double Digit Returns From Your Funds

Taking into account the performance of the funds in various categories, we have chosen various sectors and the funds therein that display a very reassuring quality in terms of returns

One of the key reasons why someone gets interested in equity is its ability to give superior returns in the long run. Historically, equity as an asset class has generated returns better than most other asset classes, including physical and financial assets. In the last few years, however, returns generated by equity have been very poor, especially from the broader market perspective. Mid-cap and small-cap indices are down by more than 10 per cent over the past three years. Frontline equity indices created better returns thanks to a handful of stocks that helped the indices to move up.

All this is reflected in the returns generated by equitydedicated mutual funds. In the three-year period ending July 2020, small-cap and mid-cap-dedicated funds on an average have generated negative returns. Nonetheless, in the last one year they have turned positive. The average returns generated by equity-dedicated mutual funds amounts to just 4.19 per cent and if we extend the study to three years, the annualised return drops to just 1.06 per cent. However, analysing the performance only between two points will not show the right picture of return that you can expect from equities.


For example, Sensex, since its inception in 1979, has generated annualised return of 16.31 per cent. Since the start of the millennium, however, it has come down but still remained in double digits. The average ten-year rolling return of Sensex since 1990 is 12.2 per cent. One of the characteristics of returns by equity is that they do not come in a straight line but follow a random pattern around the mean. The above graph clearly shows this pattern. In some years they have generated returns better than the average while in other years they have dipped real low. Nonetheless, they have the tendency to revert to the mean.



This is not only applicable to frontline indices but to broader markets also. Moreover, not all the sectors or categories perform in tandem. What this means is that not every category goes down at the same time or rises at the same time. Different sectors perform at different points of time. Smart investors can exploit this phenomenon to generate better returns on their investments. In the following paragraphs we will try to figure out what are those sectors, themes or categories that are going to put up their best performance in the next couple of years.

Choosing Sectors and Funds

Based on the historical performance of different indices and categories, we tried to draw out a pattern. On the basis of this pattern, we figured out which are the sectors and categories that are set to perform from here on. Once we arrived at these sectors and categories, we delved deep into the funds from these categories and zeroed down on those funds that stand out in three criteria. These three criteria are capture ratio, geometric information ratio and maximum drawdown.

Within the capture ratio we preferred those funds that have a lower downside capture ratio. One of the reasons for selecting these ratios is from a risk management perspective. The fund should be such that it falls less than its peers and benchmark. From the valuation perspective we are at a historical high and do not rule out volatility going ahead, and hence our selection criteria is such that it gives preference to funds that fall less in a falling market but are good enough to capture most of the rising market. All the calculation is done based on the weekly returns of the funds since their inception. In the following paragraphs, we will take you to some of those categories and funds that we believe are going to perform well and generate returns in double digits.

Small-Caps, Big Returns

Historically, we have witnessed that small-caps do not underperform for more than two years consecutively. Since the start of 2003, BSE Small-Cap has never generated negative returns in two years in a row. However, in the current situation, we see they have yielded negative returns in the last consecutive two calendar years after a stupendous performance in the year 2017. Even year-till-date they have generated negative returns.



Therefore, purely relying on historical performance, we believe going ahead we may see the small-cap-dedicated funds generating better returns. What also supports this theory is year-till-date performance. Small-cap funds have performed better than many pure equity categories. On average, though small-cap funds have yielded negative returns, they have managed the show better than large-cap, large and mid-cap and multi-cap dedicated funds.



Small-cap funds as a category are volatile and hence we wanted to include funds that are less volatile in their category. Besides, we have also applied the above filters.



Our reasons for recommendation are:

✔One of the highest capture ratios in the industry and very few funds to have capture ratios of greater than 100 per cent..
✔ Overall capture ratio at 140 per cent and the best part is that it has downside capture ratio lower than 60 per cent.
✔ Maximum drawdown of the fund is also one of the best in the industry. Compared to category's average drawdown of 43.75 per cent, the fund has a maximum drawdown of 34.84 per cent.

Mid-Caps Likely to Gain

In the last 10 years, if we rank the performance of the large-cap, mid-cap and small-cap funds, mid-caps have remained the top performers in four out of 10 years. The graph below shows the performance of all the different capitalisation-wise funds on a calendar year basis. The best part is that mid-caps are never part of the worst category. In the remaining six years they have stood their place in the second position. In the last 2.5 years this category has witnessed a deep cut in value and hence is likely to perform better going ahead. Even from the valuation perspective, they are not as expensive as large-caps.

On the basis of forward PE, NSE Mid-Cap index is much below its previous high reached during the year 2018. In the case of Nifty they are already trading higher than their 2007 highs. Hence, we see there is still some juice left in the mid-cap space and hence these funds are likely to give better returns in the next couple of years.



Our reasons for recommendation are:

✔One of the best funds in its category to capture the rise in the market. Historically, it has captured 92 per cent of the rise in its benchmark.
✔ At the same time, when the market falls, the fall in the NAV of the fund is least in its category. It is reflected in the downside capture ratio, which is the best in the industry at 76.
✔ Even the maximum drawdown is second in its category. The fund has witnessed maximum fall of 25.91 per cent from its peak compared to the category average of 33.61 per cent.

Pharmaceutical Sector
One of the best performing sectors year-till-date (YTD) is pharmaceutical or healthcare. The YTD of the Nifty Pharma index is up by more than 40 per cent. This is being directly reflected in the performance of pharmaceutical-dedicated funds. The YTD of pharmaceutical funds has on an average generated return of around 50 per cent. This jump in net asset values of the pharmaceutical funds in such a short duration may lead many investors to question future moves. Nonetheless, if you see the movement of the Nifty Pharma index, it clearly shows that the rise is still not done.

The graph alongside shows the 15-year journey of the Nifty Pharma index. As can be seen, it has started recovering from March 2020. Further, it is yet to reach its previous all-time high of 13,831. And once this level is breached, we might witness a further rally in this index. Therefore, even if you have missed the recent rally, there is still another opportunity waiting for you. The recent significant beat and earnings upgrades in the first quarter of FY21 for the pharmaceutical sector companies that have declared their results further vindicate this.

Our reasons for recommendation are:
✔Looking at its portfolio, the fund is best suited to play the rise in pharmaceutical sector.
✔ One of the most consistent performers in its category generating superior returns in the longer run.
✔ This fund has the best geometric information ratio in its category, which is close to 20 per cent.

IT Sector

The current pandemic has impacted different sectors in different ways. However, there are some clear winners. Information technology (IT) is one of them. The companies operating in this sector have adjusted to the circumstances have continued to deliver their products. For Q1FY21, 10 of the 13 companies that reported their results, were able to beat analysts’ estimate on a PAT basis and saw upward earnings revision for the next two financial years. Besides, the management commentary also looks encouraging alongside the robust deal pipeline. This is the reason why funds dedicated to the IT sector have delivered returns in excess of 20 per cent in the last year. IT is only second to the pharmaceutical sector in terms of performance in the last one year. On an average, IT sector funds have consistently delivered returns in double digits. In the last 10 years, on an average, they have yielded a return of around 14 per cent annually.

Our reasons for recommendation are:

✔Most of the funds in this category are doing well and cannot be differentiated much. We selected this fund due to its ability to capture the upside returns better than its category.
✔ The fund has generated the best return in its category in the longer run.
✔ The fund has one of the best geometric information ratios in its category and is close to 10 per cent.

Conclusion :

Most of the mutual fund schemes have seen their net asset values increase in double digits in the last four months. Nonetheless, economic uncertainty remains and that may induce volatility in returns. Hence, we suggest that you invest in these funds in a staggered manner or through SIP. Moreover, the allocation of these funds will depend upon your risk profile. However, we do not recommend more than 20 per cent of your total portfolio in sector funds for a longer duration.