The top 5 equity funds

2005 is likely to be remembered as a year when the two major mutual fund segments, i.e. equity funds and debt funds, pitched in starkly divergent performances. While equity funds (much to the glee of investors), rode the bull run, investors in the debt funds segment had little reason to cheer.

Equity markets took off from where they closed last year and continued to scale record highs. The BSE Sensex appreciated by more than 40% during the year and even breached the 9,000 points mark. Equity funds benefited from the rally to clock impressive returns.

2005: Top-performing diversified equity funds

Fund houses made the most of the rising markets by launching a number of new fund offers. For the uninitiated, NFO is a new term coined by the mutual fund industry after the regulator objected to fund houses referring to new launches as IPOs.

The year began with mid cap stocks outperforming large cap stocks. Fund houses were busy launching NFOs of the mid cap and flexi cap variety. This was followed by a slew of theme-based funds. Every opportunity right from growing consumerism to competitive strengths in outsourcing and manufacturing among other areas, was presented as an attractive 'investment theme.'

However, towards the later half of the year, good old large cap stocks made a comeback to score over their mid cap peers. Expectedly fund houses took a U-turn and launched large cap NFOs, despite already having large cap funds in their kitty.

Close-ended funds also made a comeback with fund houses finally waking up to the advantages of investing in equities for the long-term. Tax-saving funds (also termed as ELSS) came to the fore, thanks to the changes made in the budget. The erstwhile Section 88 which contained sectoral caps on various tax-saving instruments was replaced with Section 80C.

In the new tax regime, sectoral caps were removed. As a result, the 'eligible' investment limit in tax-saving funds grew from Rs 10,000 to Rs 100,000. This bodes well for high-risk investors as they can now conduct their tax-planning exercise in line with their risk profile. This year also saw fund houses bundle their offerings with insurance products.

The mutual fund industry witnessed a fair degree of churn in fund managers. In some cases, the fund manger's time of exit was inopportune and unfair to investors. This highlighted the need to invest in funds from process-driven houses rather than being married to the fund manager.

Debt fund investors on the other hand had a rather docile year. The uncertain interest rate scenario coupled with fears of rising inflation took their toll on the performance of debt funds. The gravity of the situation was not lost on the authorities either.

It was decided that the monetary policy review would be conducted on a quarterly basis. Repo and reverse repo rates were revised upwards during the year perhaps indicating an upward trend in interest rates going forward.

Capital preservation became the mantra for debt funds in 2005. Fund houses launched close-ended schemes with a fixed maturity wherein the yield is locked at the time of investment.

This ensured that investors would receive the stipulated return on maturity. These funds typically invest a tiny portion of their corpus in equities to provide the much-needed impetus to returns.

What investors can expect in 2006

While it would take a soothsayer to foretell how the markets will behave in 2006, we believe over a 3-Yr time frame, equity fund investors can expect a return of 15% CAGR (compounded annualised growth rate).

However the key will lie in being invested in the right funds. With markets trading at record highs, some might be tempted to take on higher risk for clocking superior returns. We advise investors to steer clear of such temptations and adhere to their asset allocation.

Now is as good a time as any, to create a portfolio which can help you achieve your long-term needs. Also investors would do well to block all the noise coming their way in the form of NFOs.

Rather they should build a comprehensive portfolio of conventional 'bread and butter' equity funds with proven track records from established and process-driven fund houses.

Debt fund investors should consider investing in floating rate and short-term funds until a more stable investment environment emerges.

For investors looking at a slightly higher return than the conventional debt fund, Monthly Income Plans can also be considered, but the higher degree of risk on account of the equity component must be factored in.

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