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Has your mutual fund missed the recent rally? - Outside View by PersonalFN

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Has your mutual fund missed the recent rally?
Mar 7, 2012

Has your mutual fund missed the recent rally? How many times you have been taken by surprise by the equity markets? Maybe always or most of the times when you'd speculated over the direction of market; right? We started 2011 with 20,561 on BSE Sensex. Who would have imagined that such levels would never be tested in the entire 2011 again? In fact, many "experts" were predicting a new all-time high for the Sensex at the onset of 2011. The lowest point of the year was reached on December 20, 2011 when the Sensex closed at 15,175. By this time, again, the same "experts" started lowering their "targets" for BSE Sensex and even many of you would've got convinced that we were heading for a new low. Proving all the bears wrong, markets rallied relentlessly to touch 18,428 on February 21, 2012; a 2,900 points rally since the beginning of this year. Did you feel left out in the rally? Well, if yes then you are not alone; many savvy investors and big institutional investors too have missed this rally. Let's run a check on how have the mutual funds performed?

For any fund, to be classified as an equity oriented fund, it is mandatory to hold minimum of 65% of its assets in equities. In other words, mutual funds have been given a lee way to hold up to 35% of their assets in debt, cash and cash equivalents. The main purpose why mutual funds hold cash and equivalent assets is to honour the redemption requests. However, in reality mutual funds vary their cash holdings not only to maintain the liquidity for the aforesaid reason but also to take advantage of market fluctuations. For example, when markets rise and fund manager expects a fall; he would cash out the gains and increase the cash level. On the other hand a fund manager would deploy his cash aggressively when he is bullish about the market.

At the end of 2011 many funds held high level of cash in their portfolios as they were expecting markets to fall further. Cash and equivalent assets come handy during the market downfall. They help fund managers to buy stocks cheap when market falls and increasing cash exposure at the time when the market is ripped for the fall helps in curbing loses.

Funds with high cash holdings
    Cash and Cash equivalents as on (% of assets)     Cash and Cash equivalents as on (% of assets)
SR No Scheme Name 30-Dec-11 SR No Scheme Name 30-Dec-11
1 Religare Equity (G) 37.1 11 Edelweiss Absolute Return (G) 13.7
2 Sundaram Equity Multiplier (G) 23.0 12 Sahara Super 20 (G) 13.5
3 Axis Midcap (G) 19.6 13 Sahara Star Value (G) 13.5
4 Principal Smart Equity Fund (G) 19.4 14 L&T Growth (G) 13.0
5 Peerless Equity (G) 18.7 15 Birla SL Pure Value (G) 12.9
6 Taurus Star Share (G) 16.8 16 Taurus Discovery (G) 12.9
7 Taurus Bonanza (G) 15.6 17 Sundaram Select Focus (G) 12.8
8 Sundaram Select Midcap(G) 15.2 18 Edelweiss EDGE Top 100-A (G) 12.1
9 Reliance Small Cap (G) 14.1 19 L&T Opportunities(G) 12.1
10 SBI Magnum Emerging Businesse s(G) 13.8 20 DWS Investment Opp (G) 11.8
Portfolio data as on December 30, 2011
(Source: ACE MF, PersonalFN Research)

We considered 160 equity diversified schemes (barring sector and thematic funds) for our analysis and have listed above the top 20 schemes by their cash holding as a percentage of total assets. Holding excessive cash is a two way sword. If the market doesn't go down as per the expectation of the fund manager; the fund loses on opportunities. The worst may come if the fund manager maintains elevated levels of cash hoping for the correction and instead the market rallies. In this case, the fund would not only miss the market rally but it would become even more difficult for the fund manager to deploy excess cash after the rally has happened.

Cash holding of diversified equity schemes
  Number of Schemes
>10% of total assets 30
>5% but <10% of the total assets 64
<5% of the total Assets 66
Portfolio data as on December 30, 2011 and 160 diversified equity schemes were considered for analysis
(Source: ACE MF, PersonalFN Research)

It is clear from the above given table that about 19% of the total equity diversified funds held cash in excess of 10%, around 40% of the funds held cash in excess of 5% but less than 10%. Rest, 41% of the funds held cash less than 5%. It is noteworthy that only 41% funds were near of being fully invested when markets were warming up for a rally and one in every five funds was expecting markets to drift down further.

At this point you would be very curious to know about the performance of these funds. Well, the performance is not very encouraging as only 33% of the schemes have outperformed the broader markets over last 2 months. Just 51 out of 160 diversified funds have outpaced the BSE 200. Only 4 out of 30 funds that held cash in excess of 10% at end of December 2011 have outperformed BSE 200. The performance of those (64 funds) which held cash in the range of 5%-10% has also been lacklustre. Only 20 of them have outperformed the BSE 200 over last 2 months. The outperformance comes majorly from those funds which held cash less than 5% of their assets.

How diversified equity mutual funds have fared in the recent rally?
  Returns (%)
  2months 3 months
Category average returns -1.6 -0.8
Average Returns by the Top 20 performers 22.6 10.8
Average Returns by the Bottom 20 performers 11.0 3.0
Returns generated by BSE 200 17.9 7.3
NAV Data as on March 2, 2012 and returns above are on an absolute basis
(Source: ACE MF, PersonalFN Research)

As a category, mutual funds have disappointed in the recent rally with average returns of -1.6%. This indicates that when broader markets have rallied about 18%; the equity diversified funds as a category have failed to catch up.

Top 20 performers of the recent rally
Sr No Scheme Name 2 Month Returns (%) Sr No Scheme Name 2 Month Returns (%)
1 JM Core 11 (G) 31.1 11 ICICI Pru Discovery (G) 21.1
2 HSBC Midcap Equity (G) 28.7 12 Tata Equity P/E (G) 20.9
3 JM Basic (G) 26.6 13 HDFC Mid-Cap Oppor (G) 20.9
4 ICICI Pru Midcap (G) 25.3 14 Reliance Vision (G) 20.8
5 HSBC Small Cap (G) 24.9 15 Kotak Midcap (G) 20.7
6 Templeton India Growth (D) 22.9 16 Sundaram S.M.I.L.E Fund (G) 20.6
7 Reliance Equity (G) 22.5 17 Sahara Midcap (G) 20.5
8 Sahara Star Value (G) 21.8 18 Principal Growth(G) 20.3
9 Canara Robeco Emerging Eq (G) 21.5 19 Principal Emerging Bluechip (G) 20.3
10 DSPBR Small & Mid Cap (G) 21.2 20 HDFC Equity (G) 20.1
NAV Data as on March 2, 2012 and returns above are on an absolute basis
Note: Despite it being a thematic fund, we have considered JM Basic for our analysis since it has been carrying the
portfolio that resembles with that of a diversified equity fund.
(Source: ACE MF, PersonalFN Research)

Listed above are the top 20 funds that have convincingly beaten the BSE 200 by generating returns in excess of 17.9% generated by the Index. JM Core 11, a fund carrying a concentrated portfolio, has taken the market by storm by generating as much as 31.1% returns in just 2 months. On the other hand some prominent funds in the equity diversified category have underperformed BSE 200 over 2 month period.

And some laggards....
  Returns (%)
Scheme Name 2 Months 3 Months
UTI Oppor (G) 13.1 6.5
Tata Pure Equity (G) 13.5 5.8
Birla SL Frontline Equity (G) 14.2 5.1
Fidelity Equity (G) 14.5 5.2
IDFC Premier Equity (G) 15.0 6.2
Franklin India Bluechip (G) 15.2 6.5
SBI Magnum Multiplier Plus'93 (D) 16.1 7.5
BSE-200 17.9 7.3
NAV Data as on March 2, 2012 and returns above are on an absolute basis (Source: ACE MF, PersonalFN Research)

Table given above demonstrates that some widely tracked mutual funds have disappointed during the recent market rally. There are various reasons for their underperformance. We discuss here the major ones.

What went wrong?

The recent market rally belonged to interest rate sensitive sectors such as Real Estate, Banks, Capital Goods and Autos. The chart given below indicates that BSE reality jumped 34.7% over last two months. On the other hand; defensive sectors such as IT, FMCG and Healthcare have grossly underperformed the broader markets and the sector indices tracking these sectors have gained 4.8%, 3.7% and 9.3% respectively.

Performance of sectoral indices vis--vis performance of broader Indices
Index Returns (%)
2 Months 3 Months
BSE Realty 34.7 11.4
BSE BANKEX 30.7 13.7
BSE METAL 28.0 9.7
BSE Capital Goods 27.3 3.9
BSE Power 26.7 12.6
BSE AUTO 22.7 12.0
BSE Consumer Durables 21.8 10.8
BSE PSU 20.1 8.2
BSE OIL & GAS 12.8 2.3
BSE Health Care 9.3 4.6
BSE IT 4.8 6.6
BSE FMCG 3.7 0.5
BSE SENSEX 13.7 4.7
BSE MIDCAP 23.7 10.1
BSE 200 17.9 7.3
NAV Data as on March 2, 2012 and returns above are on an absolute basis
(Source: ACE MF, PersonalFN Research)

Furthermore, not all market capitalisation segments have gained proportionately. BSE Sensex, which is a 30 share large cap index, has gained 13.7%. BSE 200; which represents the broader market movement, has gained 17.9% but BSE midcap has outperformed both these indices by generating stunning 23.7% returns over last 2 months. Clearly, midcaps have surpassed their large cap counterparts.

Listed below is the chart that tells us the sectorial composition of BSE 200. Top 5 sectors of BSE 200 together form 66.7% of the index. Banking and Finance has been the largest constituent forming almost a quarter of the index. Stupendous rally in stocks belonging to Banking and Finance has helped BSE 200 to gain 17.9% in the first two months of 2012.

Sectoral allocation of mutual funds vis--vis sector allocation of BSE 200
  Finance Oil & Gas I.T. FMCG Auto
BSE 200 25.5 11.7 11.4 9.6 8.5
Birla SL Frontline Equity (G) 18.1 4.0 11.7 8.9 8.9
Fidelity Equity (G) 21.8 7.1 11.3 9.4 4.7
Franklin India Bluechip Fund (G) 17.3 4.4 13.7 0.9 5.4
JM Core 11 (G) 36.8 0.0 10.8 0.0 19.8
JM Basic (G) 26.0 5.7 0.0 2.7 21.2
Sahara Star Value (G) 12.0 0.0 0.0 3.6 10.7
(Figures in Percentage)
Scheme portfolio data as on December 30, 2011 and sector allocation for BSE 200 are as on January 11, 2012
(Source: ACE MF, PersonalFN Research)

Those funds which were underweight on the rate sensitive sectors and overweight on Defensive sectors have missed the rally. On the other hand, funds which were underweight on defensive sectors and overweight on rate sensitive sectors have gained in the rally. For example, JM Core 11 had no exposure to oil & Gas and I.T. but it was overweight on Banking and Finance, Auto, Capital Goods and Metals; the winners of the rally.

Our View

It is important for investors not get carried away by the recent performance of the funds. Leader of a bull market can also be the biggest losers in the subsequent bear market. In this case, JM Core 11, Reliance Equity and JM basic have been one of the worst performers in the bear cycle of 2008-09 and also in the recovery phase followed by the bear phase. Moreover, a sector heavy portfolio may result into huge losses if the sector is dragged down by any bad news or any negative development on the fundamental front.

One should assess the performance of funds across the market phases before deciding upon the mutual funds to invest in. The funds that beat their benchmarks consistently on various time frames are more dependable. However these are not the only parameters one should look at while shortlisting mutual funds for investment.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.


The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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