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Have services industries MFs served your portfolio well? - Outside View by PersonalFN
 
 
Have services industries MFs served your portfolio well?

The Indian telecom industry has been in limelight for possibly all wrong reasons in last few months. But having said that, nothing can be taken away from the success it has achieved by growing ferociously in relatively a short span of time. With a subscriber base of 865.71million as per the records of telecom regulator - Telecom Regulatory Authority of India (TRAI), India ranks second in terms of number of users and has been one of the fastest growing markets all over the world. Likewise the IT industry too, which has been a poster boy of India's growth story, has earned immense respect for itself over last two decades across the globe.

But that's not all; because the services industries theme is rather broad and comprises host of other sectors as well such as banks, Non-Banking Financial Companies (NBFCs), financial services firms, IT, telecom services, power, shipping, media, and education & training to name a few.

Sector wise constituents of CNX Service Sector index
(Data as on September 30, 2011; Representation to hotels is miniscule 0.46%)
(Source: NSE, Persona FN Research)

While population has always been construed as major threat, interestingly it is this growing population which has played a vital role in the growth of services industries theme. It is noteworthy that India's demographic study reveals that the country has fairly young population (as compared to the countries in the developed economies), where large pool of young talented population works in the aforementioned services industries theme. Take for instance the IT or BPO industry. It has fairly young employees who contribute with zeal and enthusiasm to the growth of their respective companies, which in turn has resulted in the astronomical growth of the respective industries. Similarly, sectors which have fuelled India's consumption story such as banking & financial Services, media & entertainments too have contributed a lion's share in the progress of services sector.

The services industry theme has shown a stable growth of 6.7% in the span of 10 years starting from 1983. Moreover post liberalization - i.e. for the period 1993 to 2003, the growth rate posted by the theme has accelerated to 8.2% and thereafter until recently has recorded a double-digit growth of 10% year-on-year as per the records of Ministry of Finance.

Also the share of services in GDP too has been constant rise for nearly last two decades. The last economic survey (of 2010-11) conducted by the Ministry of Finance, reveals that services industries accounts for more than half - to be precise 55.2% of India's GDP for the year 2009-2010, and has sustained growth over decades; and it is this significant contribution which has caught investors' attention and also enticed several mutual funds launched funds focusing solely on "services industries".

Services Industries Funds launched by fund houses
Scheme Name Date of Inception
Tata Service Inds(G) 11-Apr-05
ICICI Pru Services Inds(G) 30-Nov-05
UTI Services Inds(G) 01-Aug-05
Principal Services Inds(G) 06-Mar-06
(Source: ACE MF, PersonalFN Research)


Tata Mutual Fund was the first fund house to launch thematic fund in this category. Initially (at the time of inception), while most fund houses garnered roaring AUMs under this theme, the recessionary phase witnessed in 2008 until March 2009, forced many investors to exit from the theme in panic thus resulting in AUMs dwindling. After witnessing a high in AUM of Rs 1,918 (for all the aforementioned 4 funds) as on December 31, 2007, the same stands at barely Rs 588 crore as on September 30, 2011, as panic selling led to investors exit from their investments.

Data as on September 30, 2011
(Source: ACE MF, PersonalFN Research)

The chart below reveals that the CNX Service Sector Index (which is computed using "free float market capitalization weighted method") which is used to benchmark the performance of the companies in the services industries theme, over a decades time frame has not only outperformed broader index S&P CNX Nifty by a good margin, but has also arrested the downfall of the equity markets well. Moreover, in the recovery phase of the Indian equity markets it accelerated much faster than the S&P CNX Nifty index.

S&P CNX Nifty vs. CNX Service Sector
Base: Rs 100
(Source: NSE, Personal FN Research)

Hence, say if one to were to invest a sum of Rs 100 each in the S&P CNX Nifty and the CNX Services Sector Index a decade back - on November 1, 2001, the same would have yielded a sum of Rs 536 and Rs 634 as on October 31, 2011 on November 1, 2001.

How Services Industries Funds have fared?
Scheme Name 6 Months (%) 1-Yr (%) 3-Yr (%) 5-Yr (%) Std. Dev Sharpe Ratio
Tata Service Inds (G) -7.7 -21.1 23.3 4.6 9.59 0.14
ICICI Pru Services Inds (G) -8.2 -12.0 22.4 4.3 7.96 0.14
UTI Services Inds (G) -10.0 -14.4 21.9 4.0 7.61 0.15
Principal Services Inds (G) -11.3 -18.6 19.2 3.3 7.03 0.14
Average of all services ind funds* -9.3 -16.5 21.7 4.0 8.05 0.14
Average of all diversified equity funds* -7.6 -15.8 25.1 7.5 7.41 0.19
BSE SENSEX -7.5 -11.6 21.8 6.4 8.16 0.13
CNX Service Sector -8.6 -11.7 20.9 7.0 7.79 0.13
(NAV data is as on November 1, 2011. Standard Deviation and Sharpe ratio is calculated over a 3-Yr
period. Risk-free rate is assumed to be 6.37%)
*It is a simple average of all the funds in the respective categories)
(Source: ACE MF, PersonalFN Research)

As far as the performance of services sector industries funds is concerned, the return generated by them over a 3-Yr time frame are quite luring. Barring Principal Services Industries, all other funds have outperformed their benchmark over 3-Yr time frame. On the volatility front too, all services industries funds have kept their risk well under control (as revealed by their Standard Deviation), which have helped by them to clock appealing risk-adjusted (as revealed by their Sharpe Ratio) returns as well.

But if we assess the category average of all services industries funds, vis--vis the category average of all diversified equity funds, the returns over a 3-Yr time frame still falter, when compared to diversified equity funds as they have been able to clock better risk-adjusted returns.

Speaking about the portfolio characteristics, being thematic in nature most services industries funds hold a concentrated portfolio. As per the latest disclosed fund-facts, as on September 30, 2011 the allocation to top-10 stocks has been in the range of 48.7% - 62.9%, while the allocation to top-5 sectors has ranged from 53.0% - 79.0%. But an interesting point is that despite having on an average 35 stocks in the portfolio, the churning across schemes has been moderate with a portfolio turnover ratio ranging between 0.14 times to 0.97 times.

However despite this, the whole category has not only failed to beat the category of equity diversified funds but also has underperformed CNX Service Sector index over 5-Yr time frame. We believe that this underperformance is mainly attributed to the poor stock selection in an attempt to beat the benchmark distantly and partially due to restriction on these funds to invest in a particular theme. Also a noteworthy point for the said thematic funds is that aggressive cash calls taken at the wrong time could have turned out to be nightmares.

Road Ahead...

Potential of services industries can never be undermined in a country which is in the developing stage and young population to advantage along with a growing middle class. But going forward the challenge of retaining competitiveness would be important. Sectors such as Banking and Financials, which usually grow with the economy, would play a key role in the overall performance of services industries theme (and also the consumption theme). India is a power deficit country and to sustain the growth rate of 8% and above; development in the power sector too is vital. Education, healthcare, travel & tourism too are yet to witness a boom which expands the scope of further growth in this theme.

What should investors do??

While services industries funds so far have delivered luring returns, we believe that the limited ambit for stock selection often exposes them to portfolio concentration risk and sometimes even high churning. While many have preferred to invest in services industries funds to ride the boom, they have suffered because of high portfolio concentration risk when detrimental economic factors affecting the theme have taken place. And mind you, distressed redemptions coming at the time when sector tanks prove to be a double whammy.

Hence in order to safeguard yourself against all the thematic risk, we believe investors would be better-off by investing in diversified equity funds as the benefit of diversification enables you to reduce the risk of the portfolio. Moreover, diversified equity funds too can help you tap investment opportunities in services industries theme, along with the other promising themes as well. But while investing we recommend you investors to invest those funds which have a minimum 3 year track record, and prefer fund houses which follow strong investment processes and systems. Moreover, while investing in diversified equity funds have a time horizon of 3 to 5 years.

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

Disclaimer:
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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1 Responses to "Have services industries MFs served your portfolio well?"

John Adams

Nov 11, 2011

The article gives the Sharpe Ratio for a number of telecoms firms. Could you also specify their Omega Ratio (as described at http://investexcel.net/219/calculate-the-omega-ratio-with-excel). It's a better performance benchmark, and penalizes the risk of extreme losses (the Sharpe Ratio, on the other hand, simply penalizes the variance).

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