Equity funds: Turnaround song

Kripa Mahalingam

After two years of negative returns, equity markets, will reverse its losing streak and finish the year on a positive note.

So, it's no surprise that most of the actively managed equity funds, also find themselves in positive territory. But, what's surprising is that an overwhelming majority of equity funds have managed to outperform the benchmark indices this year.

According to data provided by Value Research, almost 93 per cent of diversified equity funds have outperformed the Nifty.

We take a closer look at the funds' performance to figure out factors helping achieve such remarkable results. For our study, we have only considered truly diversified growth schemes.

To begin with, the Indian equities market does not offer too many investment options. Given that the investible universe of stocks are limited, the portfolios of almost all diversified equity mutual funds tend to look similar.

But what makes them different is the weightage that every stock gets in a portfolio and that's primarily the reason why equity funds give divergent returns.

Says Nitin Raheja, fund manager- equities, Sun F&C Mutual Fund, "The weightage given to stocks and asset allocation essentially defines a fund performance."

The weightage given to stocks in the index are distinctly different from individual fund portfolios.

For instance, Hindustan Lever has a weightage of 11.51 per cent (as on December 24) while exposure of almost all equity funds to this stock has only been nearly around five per cent.

Funds have been trimming its exposure to the stock, given its bleak growth prospects, and its no surprise that the stock fell 20 per cent in the past one year.

Unlike previous years, the rally in equities has been more broad-based this year. So, fund managers taking advantage of the broad-based rally have hiked their exposure to small and mid-cap stocks.

Restructuring stories such as Thermax, public sector companies and banks as Neyveli Lignite, Engineers India and banks--both private and public sector, turned out to be fund favourites.

All these scrips have gained more than 100 per cent during the year adding hefty gains to the fund portfolios. In fact, the top performing fund, Reliance Vision made most of its gains from small and mid-cap stocks.

The fund had a 27 per cent exposure of its equity portfolio to non-index scrips in March, later hiked to 57 per cent in September.

Currently, non-index stocks still constitute 45 per cent of the fund's top holdings . On an average, most mutual funds have a 20 per cent exposure to non-index scrips.

But looking beyond the index scrips was no surefire way to make money in this market. Even funds which invested in large cap stocks, which are major constituents of the index, still ended up making reasonable gains. Take the case of Franklin India Bluechip which clocked a return of 20.90 per cent and Zurich India Equity which generated a return of 25.10 per cent this year.

The good performance stems from the fact these funds have stayed reasonably diversified across sectors at all times and have invested in quality stocks. Says K N Shiva Subramanian, fund manager of Franklin India Bluechip, " India is still a stockpickers' market."

And indeed it is. Since no particular investment theme drove the market this year, it called not only for good stock picking skills but nimble sector rotation.

For instance, it was the public sector stocks that drove up the markets in the beginning. Then it was the turn of small and mid-cap stocks to drum up investor interest.

After a quiet year, tech stocks were back in the reckoning and the banking sector witnessed a re-rating as the Securitisation Bill was passed. So equity funds which have managed to spot opportunities early across the sectors have stood to gain.

Says Vetri Subramaniam, chief investment officer, Kotak Mahindra Mutual Fund, "It was a market where it was not only important to know when to buy but also to know when to sell."

Most mutual funds this year have not been afraid to move to cash in uncertain times in order to protect their gains. For instance, Kotak Mahindra Mutual Fund, maintained cash levels of 30 per cent plus in May when markets tanked following the Indo-Pak tension. It has since been brought down to around 5 per cent currently.

However, not all funds have got it right. Take the case of one of the oldest equity funds, Birla Advantage. It could only garner a return of 3.39 per cent in the past one year. It was their overweight positions in oil PSU companies and pharma companies that dented their overall returns.

The fund has pared its exposure in these sectors and hiked their exposure in the auto and technology sectors. "We are already starting to see gains," says Paras Adenwala, fund manger of Birla Advantage.

Another factor why actively-managed funds are able to outperform the index is the absence of pension funds in the equity markets.

Explains Subramanian, "Long-term money in the form of pension and other funds is normally indexed. If more and more money gets invested into passive indices, it may be difficult to outperform the index in a rising, bull market."

However, there is no guarantee that this performance will sustain next year. Most fund managers agree the market valuations are extremely attractive and should do better next year.

But, as an investor, we advise you not to look at this year's performance alone in isolation. We recommend that you look at the longer term performance of a fund before you invest in a fund because this year's winners could well end as next year's losers.

2002: The Year That Was

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