Large cap funds are more liquid - The Honest Truth By Ajit Dayal

Large cap funds are more liquid


The Honest Truth on the hidden, undisclosed and potentially dangerous illiquidity risk in small-cap and mid-cap funds led to a question from Mr. Rajat to see if we can do a similar study for large cap funds?

So, with the help of the diligent research team at PFN, here is their output on the liquidity of the five largest (by AuM) large cap equity funds.

Studying the liquidity of five of the more popular large cap funds (and, for good measure throwing in the Quantum Long Term Equity Fund from the Quantum AMC stable, which I helped set up and in which I have a significant majority of my equity mutual fund investments) I maintained the following assumptions and logic used for the analysis of the small-cap and mid-cap funds:

  1. On any given day, the Fund cannot sell or buy more than 33% of the average daily trading volume of the past one year, of the underlying stocks that it owns;
  2. This assumption of 33% is pretty safe in the sense that, if the Fund was to be a buyer or seller of that stock of >33% of that stocks long term average daily volume, the Fund can disproportionately influence the price of that stock by its action of buying or selling;
  3. If the price moves too much on "light trading volumes", the NAV may be impacted significantly. Investors look at an NAV as a guide to invest or redeem. Assuming that the markets are surging and the NAV of your mid cap fund starts spurting northwards. You may decide to redeem. If a large number of investors decide to act the same way you do on that specific day, the Fund should be able to liquidate its holdings to pay off all the claims. The declared daily NAV implies it is liquid and "transactable": a transaction can happen at that price. That may not be the case.
Table 1: No surprises: Large cap funds are more liquid than small cap funds!
Fund name (change in AuM) Month ended, 2017 AuM, Rs cr Expense Ratio Top Holding, Days Minimum Days Maximum Days
Aditya Birla SL Frontline Equity March 31 16,352   7 3 8
(16.0%) Sept 30 18,969 2.11% 10 4 10
SBI BlueChip Fund March 31 12,586   9 2 65
(24.4%) Sept 30 15,654 1.97% 11 3 40
HDFC Top 200 Fund March 31 13,945   11 3 14
(5.1%) Sept 30 14,655 2.05% 9 3 13
ICICI Pru Focused Bluechip March 31 12,843   10 3 18
(12.4%) Sept 30 14,439 2.10% 8 3 20
Kotak Select Focus Fund March 31 9,323   2 2 48
(49.6%) Sept 30 13,947 1.97% 8 2 12
Quantum LT Equity Fund March 31 730   2 0.2 2
(10.2%) Sept 30 805 1.46% 2 0.2 2
S&P BSE 100 Index March 31 9,494        
(7.2%) Sept 30 10,173        
Source: PFN, ACE, BSE, NSE

The results of this analysis (see Table 1) bring up a few interesting points:

  1. Between March 31 2017 and September 30 2017, only 2 of the funds - Kotak and PruICICI outperformed the S&P BSE 100 Index (this may not be the official benchmark for each of them, but I used one "common" Index); as an aside and in full disclosure "my very own" Quantum Long Term Equity Fund did the worst of the 6 funds during this time period: QLTEF had a gain of +4.75% v/s 6.59% for its benchmark BSE-30 Total Return Index and +8.07% for the BSE-100 Index! ☹
  2. The AuM grew for all funds (except HDFC), and increased more than the gain in the BSE-100 Index - this suggests that the five funds collected more money in this time period by issuing new units to existing or new investors;
  3. But, despite the large AuM inflows (note the very impressive AuM growth of 49.6% for Kotak and 24.4% for SBI) liquidity of the underlying Top 10 stocks in 4 of the 6 large cap funds' portfolios improved or remained at levels that should cause no undue alarm to an investor. The exceptions Aditya Birla and ICICI Pru where there was a marginal (about 10% ) decrease in liquidity based on the Maximum Days it would take to exit the least liquid stock in the Top 10 Holdings.

Nothing alarming really about the data on the large cap funds: they are relatively liquid. The NAV - unlike what we saw in the small-cap and mid-cap fund analysis - is pretty much a "transactable NAV".

What you see is what you will get.

Some interesting observations

HDFC is the only fund that is in the common list of Top 5 small-cap / mid-cap and Top 5 large-cap equity funds.

That speaks of the reputation the fund house enjoys in the industry and within the channels that market its easy-to-sell brand name.

We can compare the liquidity - or illiquidity - of two equity products offered by the same fund house which happens to be in the "Top 5" (in terms of AuM) within each category.

Table 2: Are both the HDFC Funds really the same level of risk?
Fund name (change in AuM) Month ended, 2017 AuM, Rs cr Expense Ratio Top Holding, Days Min Days Max Days
HDFC Midcap Opp March 31 15,734   206 2 206
(13.9%) Sept 30 17,917 2.24% 364 6 364
HDFC Top 200 March 31 13,945   11 3 14
(5.1%) Sept 30 14,655 2.05% 9 3 13
Source: Personal FN, ACEMF, BSE, NSE

Both the HDFC funds are rated as "4-Star" and "Gold" by Morningstar.

The AuM of the less liquid HDFC Midcap Opportunities Fund was higher for the period ending March 31, 2017 and September 31, 2017.

The Midcap Fund has not done better than its benchmark NSE 50 Midcap Index (7.53% for Index v/s 6.69% for Fund).

The Top 200 Fund has not done better than the BSE 200 Index (8.13% for the Index and 5.51% for the Fund).

The Top 200 Fund has done better than the Midcap fund over this very short 6-month time period: so while that is a data point, it may not be consequential.

Yet the Midcap Fund has raised more money (it does have a higher expense ratio, so maybe more incentives to distributors) suggesting that mid-caps have been a "hot" space to be invested in.

The fact sheet provided by the mutual fund house states that both funds are Moderately High in the SEBI-prescribed Riskometer.

However, there is reason to believe that the HDFC MidCap Fund is, by virtue of being less liquid than its stable-mate, the HDFC Top-200 Fund, a more risky fund.

Its NAV may be declared but, under periods of stress and excessive redemption pressures, the NAV you see may not be the NAV you get.

Again, none of this takes away from the fact that investors - once you understand the risks they are taking - could invest in mid-cap and small-cap funds as part of your overall exposure to stock markets.

But recognize that the mutual fund houses are not likely to either:

  1. realise the inherent risks in their products, or
  2. worse: they may realise it but may not be comfortable discussing these risks with you and praying you never ask the question!

Well, now you know what to ask every fund house.

Suggested allocation in Quantum Mutual Funds (after keeping safe money aside)

Quantum Long Term Equity Fund and Quantum Equity Fund of Funds Quantum Gold Fund
Quantum Liquid Fund
Why you
should own
An investment for the future and an opportunity to profit from the long term economic growth in India A hedge against a global financial crisis and an "insurance" for your portfolio Cash in hand for any emergency uses but should get better returns than a savings account in a bank
Suggested allocation 80% in total in both; Maybe 20% in QLTEF and 60% in QEFOF 20% Keep aside money to meet your expenses for 6 months to 2 years
Disclaimer: Past performance may or may not be sustained in the future. Mutual Fund investments are subject to market risks, fluctuation in NAV's and uncertainty of dividend distributions. Please read offer documents of the relevant schemes carefully before making any investments. Click here for the detailed risk factors and statutory information"
Disclaimer: The Honest Truth is authored by Ajit Dayal. Ajit is Founder of Quantum Advisors Pvt. Ltd and Quantum Asset Management Company Pvt. Ltd. The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and has not been authenticated by any statutory authority. The author, Equitymaster, Quantum AMC and Quantum Advisors do not claim it to be accurate nor accept any responsibility for the same. Please read the detailed Terms of Use of the web site.

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