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Mutual Funds: A Pillar Of Support

The recent volatility in the equity market may have masked one of the discernible trends that has emerged over the last one year. What we are talking about is the surfacing of the domestic mutual funds (MFs) as a new potent force, giving direction and stability to the Indian equity market. For long, MFs in India played second fiddle role to foreign institutional investors, who use to be the driving force behind the Indian market; however, the scenario seems to be changing recently.

The Indian equity market has remained one of the best performers among the larger emerging markets in the last three months and year till date. According to data by MSCI on the emerging market equity returns in USD terms, for the three month and one year ending September 23, the Indian equity market, though having generated negative returns, was better than every country other than Hungary. One of the factors that has really helped India to outperform its emerging market peers is the strong support provided by the domestic mutual funds.

After investing to the tune of Rs 23,326 crore in the entire year 2014, the investment through mutual funds in the current year has already crossed Rs 54,000 crore and we have still three months to close the year. This is probably the highest ever investment in a single year by MFs and is greater than the cumulative investment made by MFs since the year 2000. What has led to such a surge in investments by MFs is the increase in participation by retail investors in the last 15-18 months. Better equity market returns and at the same time lacklustre performance in other asset classes such as gold and property has lured retail investors towards equity mutual funds. What is also attracting them towards equity MF is fall in the interest rate and earnings from fixed deposits.

Retail investors are increasing their exposure towards equity through the mutual fund route and that too through systematic investment plan (SIP). Although, there is no confirmed data available on SIPs, some of the media reports point towards increase in investment through this route. On an average, flows into equity schemes, which were close to Rs 1,200 crore per month in early 2014, have jumped to Rs 2,100 crore per month now. Even the average ticket size, or value per SIP, has increased from Rs 1,900 to Rs 2,500 per folio, the report said.

Moreover, we have seen a continuous increase in the number of folios in the last few quarters. Retail mutual fund folios increased for the third consecutive quarter to cross the 4 crore mark for the first time since March 2013. Retail folios rose 2.36 per cent in the latest quarter, following 3.42 per cent and 1.69 per cent rise in the preceding two quarters respectively. In absolute terms, retail folios increased by 9.43 lakh to 4.09 crore, led by the equity category.

This is a very welcome change for the Indian equity market. The channelisation of household savings towards the equity market will give the much required stability to the Indian equity market and will shield us partially if not completely from the vagaries of volatility in the global market. This has become evident from the events of recent times. From the time foreign institutional investors have been allowed to invest in India, the last quarter ending September has remained one of the worst in terms of FIIs’ outflows. Till September 22, FIIs have sold equity worth Rs 14,210 crore in the Indian market compared to Rs 16,195 crore in the December 2008 quarter, in the immediate aftermath of the collapse of Lehman Brothers.

The huge selling by FIIs in that quarter led to the fall of frontline indices by a massive 25 per cent. In the last quarter, however, they fell by 7.19 per cent. What helped and provided stability to the market was the support from mutual funds. For the three months ending September 2015, domestic mutual funds invested to the tune of Rs 21,963 crore surpassing the sell figure by FIIs in the same period. This worked to arrest the fall and in a way helped India to outperform the other emerging markets.

After this, you all must be interested in knowing in which companies these funds are being parked. Although companies are yet to file their shareholding pattern for the September quarter, an analysis of the last quarter, ending June 2015, shareholding pattern might give us some clues. We have only analysed BSE 500 companies as we believe that it covers the majority of the investment universe of mutual funds.

Out of a total 500 companies in BSE 500, only 428 companies’ complete data for the last five quarters’ shareholding pattern is available. Out of these 428 companies, mutual funds have increased their stake in 286 companies in the last five quarters. This means that a good 67 per cent companies have seen mutual funds increasing their stake. Against this there are 128 companies where MFs have reduced their stake in the same period.

The company that has emerged at the top of the list with respect to MFs increasing their stake is Multi Commodity Exchange of India, which saw MFs raising their stake from 0.4 per cent at the end of FY14 or March 2014 quarter to 16.28 per cent for the quarter ending June 2015. This was followed by Techno Electric & Engineering Company, which saw an increase of 13.16 per cent in MFs’ holding in the same period. There are 77 companies in the list that have witnessed a consistent or quarter-on-quarter increase in the MF stake in the company. What this means is that per quarter they are increasing their stake in the company with Multi Commodity Exchange of India continuing to occupy the top slot. This is followed by Strides Arcolab and DCB Bank. However, analysing the stock behaviour or returns of these companies is not within the scope of this article and we may explore this some other time.

Indian MFs hold more than 4 per cent in the BSE 500 companies, which is highest in the last five years and we believe that it is going to further increase in the coming quarters and years. The Indian mutual fund industry is in a sweet spot currently and will grow substantially going ahead. What will help its growth is a sound macro economic environment and favourable demographics, which ensure availability of long-term capital inflow. In addition to this, a proactive and conducive regulatory regime will further facilitate the industry’s growth.

Understanding that every individual has a different risk profile and sector preferences, this time we have tweaked the way we give recommendations. Instead of the top seven equity diversified funds we are presenting here top five equity diversified funds, two top sector funds and a list of top funds dedicated towards mid and small-cap companies.
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Birla Sun Life Pure Value Fund

This fund was conceptualized and launched in 2008 when the equity market globally, including India, was in turmoil and was witnessing a free fall. The idea was to benefit out of this fall and find out and invest in those companies that were trading below their intrinsic value. The fund continues to pursue the same investment strategy even now.

The strategy has paid off to benefit the investors and the fund has generated returns of over 22 per cent since its inception. It has been able to beat its benchmark index BSE 200 every year since its inception. Last year i.e. 2014 has been exceptionally well for the fund. It generated a return of 99 per cent. This helped the fund to become one of the top performing funds in the last three years. The fund’s trailing three-year return is 31.18 per cent, which is 3.84 per cent above its category return in the same period. Although the overall market sentiment has definitely helped the fund to perform, the change in guard of the fund has also helped.  Mahesh Patil and Milind Bafna have taken over the management of this fund from January 2014. The better performance indicates the ability of the fund managers to generate alpha for the investors.

If we further dissect the performance of the fund to know from where this alpha is being generated, it is from the right stock selection rather than the right sector allocation. At the end of August 2015, the fund has been able to select right stocks 61 per cent of the time. In terms of stocks that remained the top contributors of alpha for the fund is J Kumar Infraprojects.

Looking at the current portfolio, the fund is more inclined towards small-cap stocks, in which it has investments of up to 44.3 per cent, while mid-cap constituted 12.4 per cent of the total portfolio at the end of August 31, 2015. This is despite no such mention in their investment mandate. The only mandate is to pick value stocks. The fund increases its small-cap exposure whenever it finds the right picks. The fund also doesn’t compromise on corporate governance quality. The fund is best suited for those conservative equity investors who have slightly longer investment horizon and believe in value investing.
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Franklin India High Growth Cos Fund

The Indian economy’s growth rate is slated to overtake China’s pace this year and the difference might get wider going ahead, according to various agencies. When the Indian economy is expected to grow at a faster pace, Indian companies are also expected in tune with this momentum and every investor would like to be a part of this growth story. Franklin India High Growth Companies Fund, which primarily invests in high-growth companies which tend to grow their earnings at a quick clip, is one of the funds that will definitely help discernible investors.

The fund’s performance since its launch in 2007 has been decent. The fund has been able to beat its category return in every time frame except during the last six months. For example, while the category return in the last seven years has been 15.21 per cent, the fund has, comparatively, generated return of 19.82 per cent in the same time. Even for the last one year the fund has generated return of 15.86 per cent as against 9.92 per cent by category. The fund has also been able to beat its benchmark, CNX 500, every year since its launch barring in 2008 when it underperformed its category by less than 1 per cent. What is also good about the fund is that it has been able to beat its category and benchmark in both falling market (Example: Q1 CY13 and Q3 CY13) as well as in the rising market.

The fund applies a blend of top-down and bottom-up approach to zero in on the right investments. Macro analysis is done to identify the right sectors while micro analysis is applied to pick stocks within these sectors. If we dissect the performance of the fund on the basis of sector selection and stock selection, the excess return generated by the fund over its benchmark is primarily due to stock selection. The fund identifies high-growth companies with the help of valuation matrices such as EV/EBITDA growth rate, price to earnings growth rate, forward price to sales, etc. Almost 80 per cent of the stock is selected from the index (CNX 500), which is its benchmark, and despite this fund has outperformed its benchmark due to better stock selection.

The current portfolio of the fund seems to be more tilted towards large-cap companies, which constitutes 60 per cent of the total portfolio while mid-cap and small-cap constitute 11.3 per cent and 17.2 per cent respectively. In terms of stock, cyclical companies which are likely to be benefited first with the uptick in the economy, such as financials and automobiles, hold a major place in the portfolio. Therefore, this fund is most suited for those investors who believe in the Indian growth story and want to benefit out of it.
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Kotak Select Focus Fund

Focused funds, also known as “best idea funds,” are those funds that choose lesser number of companies or sectors than normal equity-diversified funds to invest in. The aim is to deliver high returns by investing in a limited number of companies. Kotak Select Focus fund is one such focused fund that has delivered superior returns since its launch in year 2009. According to the scheme information document, the fund aims to follow a concentrated sector strategy by investing generally in a few sectors that have the potential to grow. Unlike other focused funds that invest in fewer stocks within the limit of 30 or so, this fund invests in a larger number of stocks and at the end of August 31, 2015, it has investment in 54 stocks.  The fund focuses on winning sectors and then diversifies within this sector.

This strategy has helped the fund to give impeccable performance since its launch and has outperformed both its benchmark (CNX 200 index) and the category over one, two and three-year periods ended September 24, 2015. For example, in the last three-year period the fund has given return of 23.52 per cent compared to category return of 17.75 per cent. The fund has even done well on the basis of risk-adjusted performance over the same period, reflected in a higher Sharpe ratio of 1.16. The fund is also less volatile than the category. The standard deviation or volatility of the fund was 15.29 per cent vis-à-vis the category’s 17.95 per cent and the benchmark’s 19.24 per cent.

As explained earlier, the fund has a concentrated portfolio at the sector level compared with the category over the three-year period ended August 2015. The top five and 10 sectors of the fund formed 65.94 per cent and 86.23 per cent of the portfolio respectively compared with the category’s 54 per cent and 83 per cent allocation. The fund is currently overweight on financial (26.95 per cent exposure) and automobile (12.7 per cent exposure) sectors.

In terms of market cap, the mandate allows investments in mid and small-cap stocks up to 50 per cent of the portfolio. But in practice, the fund has retained a large-cap tilt, parking 70-75 per cent of its assets in large-cap stocks in the last one year and at end of August 31, 2015 the large-cap stocks accounted for 76.2 per cent whereas mid-cap formed 21.41 per cent.

As this fund is concentrated at a sector level, the performance depends upon how these bets play out. Although the fund has till now been able to ride on the right sectors, we recommend this fund to an aggressive investor since it has just completed six years and is yet to see any major downturn, which will test its performance.
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L&T INDIA VALUE FUND

L&T India Value Fund, which was launched under the Fidelity Mutual Fund banner (L&T Mutual Fund took over Fidelity Funds in 2012 and the fund was re-launched in the year 2010) had remained conspicuous by its absence in our previous few years’ study of the best mutual funds to invest. There are a couple of reasons: first, the fund size was smaller than our threshold limit and the second reason was obviously its performance. Regardless, in the last few months it has been able to overcome both of those limitations. The fund’s net asset has grown to Rs 361 crore at the end of August 31, 2015. This was helped by both funds’ inflow as well capital appreciation.

Although the fund has been generating better returns than its benchmark BSE 200 in the last few years, the performance has been exceptionally well in the last few quarters. Year-till-date (September 24) it has outperformed the benchmark by a huge margin of 11.5 per cent. Even within the category, it has outperformed by 7.5 per cent. Over a longer term the fund has been able to outperform its category. In the last three years it has generated return of 29.91 per cent compared to the category’s return of 19.5 per cent. The exposure of the fund towards low-valuation and contrarian stocks has often led to underperformance for a shorter term earlier but has been able to beat category and benchmark in the longer term.

The focus on value saw the fund adding stakes in sectors such as construction, textiles and agro-chemicals while exiting from pharmaceuticals over the past year. Yes, there were no pharmaceutical stocks in their portfolio at the end of August 31, 2015 due to higher valuation.  The fund also has a lesser exposure to the financial sector compared to its category or benchmark. What has also helped the fund to perform is its multi or flexi-cap character, which gives the fund manager freedom to juggle around with market capitalization and create alpha.

The current portfolio of the fund is built for a market that is looking forward to an economic recovery. That the portfolio has already shown signs of significant outperformance exudes confidence. The fund has stocks that are well-diversified and the number of stocks is larger than its peers. At the end of August 31, the fund had a total of 83 stocks. The top 10 stocks constitute only 27.04 per cent of the total fund. Looking at the orientation of the fund towards value and short-term blips, we believe this fund is suitable for those with a good risk appetite and longer period investment horizon.
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SBI Magnum Multicap Fund

SBI Magnum Multicap is one such fund that has improved its performance over the years. After underperforming its benchmark, BSE 500, for four years out of the first six full years of its existence, it has consistently outperformed in the last four years. Launched in September 2005, the fund underperformed its benchmark in the years 2007, 2008, 2010 and 2011. Nonetheless, after that fund has continuously outperformed its benchmark and category.

In trailing three years the fund has given annualised return of 22.65 per cent compared to category return of 17.75 per cent. Even for a smaller time frame of the last six months ending September 24, the fund has given return of 0.51 per cent against negative return of 3.62 per cent by category. The consistency of the returns is also reflected by the number of months the fund has beaten its benchmark index. Getting deeper into the reasons that have helped the fund to outperform, 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 right stock 62 per cent of the time. The alpha generated by the company is more due to right stock selection and not appropriate sector allocation. Some of the right stock selections that helped the fund generate such returns is Britannia Industries, Techno Electric & Engineering and Maruti Suzuki India.

Such remarkable returns are generated by the fund by taking limited risk. The volatility of the fund returns, gauged by standard deviation, stood at 14.96 per cent compared to 15.02 per cent for the benchmark. The Sharpe ratio for the fund stood at 2.04 compared to 0.89 for the benchmark index. One of the factors that help multi-cap funds to perform consistently is 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. However, in case of a volatile market they can again shift their fund towards large-caps, which are considered to be less volatile.

The latest portfolio clearly shows that the current focus of the fund is more towards the large-caps, which constitute almost 50 per cent of the portfolio, while mid and small-cap stocks form 47 per cent of the portfolio. In terms of sectors, the financial sector stocks dominate the portfolio with 24.04 per cent of the total portfolio followed by technology and FMCG forming 11.3 per cent and 10.60 per cent of the portfolio. We advise limited exposure to this fund to our moderate risk-taker readers.
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SBI Pharma Fund

The Indian equity market in the last few months has been witnessing a bout of volatility and frontline indices have already shaded all the gain of this year. Nonetheless, there is one sector that has bucked the trend and has given return in excess of 15 per cent. We are talking about the healthcare or pharmaceutical sector. Even in the last five years when the Sensex has generated annual return of around 8 per cent, BSE Healthcare has given a return of a whopping 37 per cent annually. Better exports along with healthy domestic growth and weakness in rupee against US dollar has helped healthcare to outperform the overall equity market.

Regardless, all the pharmaceutical-dedicated funds have not performed equally well and there are some funds that have underperformed the benchmark. SBI Pharma Fund, however, consistently topped the category, outperforming the BSE Healthcare index, its benchmark, and peer funds on a one, two and three-year basis. In the last one and three-year period the fund has given return of 41.17 per cent and 39.89 per cent on an annualised basis respectively. This is way above the category return of 32.55 per cent and 35.13 per cent in the same period. The fund has been able to generate better returns in both rising and falling markets. For example, in year 2011, when the BSE Healthcare and BSE Sensex had fallen by 13 per cent and 25 per cent respectively, the fund was able to arrest its fall to 5.54 per cent.

Going forward, this sector is expected to continue with its good performance, riding on generic revolution around the world. However, large-cap companies like Sun Pharma whose market cap has grown up multifold in the last few years are expected to display decent growth as there is lot of opportunity in this space globally. What is also important to note in the portfolio of this fund is that there is barely any company that is facing any action by USFDA. The fund’s style of holding stock is basically growth-oriented.

Better performance of the fund has not come at a cost of taking extra risk. This is better reflected in the Sharpe ratio, which is a measure of risk-adjusted return, of the fund that stands at 1.68. We advise this fund to moderate risk-taker investors to invest in this fund as concentration of the fund’s portfolio is skewed towards large-caps, giving stability to returns.

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