Of Mutual Funds, Asset Sizes and Oblivious Experts

With calendar year 2015 coming to an end, business dailies are busy publishing round-ups of the year gone by. Expectedly, performances clocked by various investment avenues have been put under the scanner. An article detailing the performance of the largest (by asset size) equity mutual funds caught my eye. In a year when equity markets have had a rough run, most of the abovementioned funds fared better than their respective benchmark indices.    

However the truly interesting bit was an expert’s take on the performance. He attributed the positive showing to a combination of active fund management and strong flows into funds. The former makes sense. In a year when large-cap stocks struggled (the S&P BSE 100 posted a loss of 3%) and small/mid-caps fared somewhat better (S&P BSE MidCap: up 6%, and S&P BSE SmallCap: up 5%), a benchmark-hugging strategy wasn’t going to work. Skilled stock-picking and portfolio management were the need of the hour.

Robust inflows aid performance?

Now for the latter part: strong inflows in equity funds aiding performance. Not only is this reasoning questionable, it also exhibits a poor understanding of how mutual funds work.

Let’s take an example: Both Rs 100 and Rs 1,000 invested in a stock that appreciates 20% over a year deliver the same annual rate of return—20%. Simply put, a higher investment sum doesn’t alter the rate of return.

Critics might argue that the return varies i.e. while Rs 100 yields Rs 20, Rs 1,000 returns Rs 200. Fair enough. But let’s not forget that inflows (a higher investment amount) also result in a proportionately higher number of mutual fund units being issued. In other words, the higher return (Rs 200 versus Rs 20) is equalised by a larger number of units, resulting in the same rate of return.

Buying on dips: Theory vs. Practical

The expert further elucidates how robust flows helped portfolio managers invest smartly during corrections. Portfolio managers would like inflows to coincide with downturns; invest on downturns and then see those stocks outperform thereon. Admittedly in theory, that premise sounds fine. However in practice things work a bit differently. 

To begin with, typically such a phenomenon plays out over the long-term, and not over a year. Furthermore, in 2015, not many of the better performing stocks displayed a ‘V-shaped’ recovery. Any manager expecting the ‘downturn-inflows-invest-upturn’ cycle to play out consistently and immediately is banking on luck.    

On the other hand, a skilled manager focuses on portfolio construction—stock and sector allocation, managing liquidity and risk, among other aspects—which in turn enables him to rejig the portfolio and increase allocation to attractively valued stocks. Hence, yet again it doesn’t take inflows to deliver a positive showing.    

Asset size and performance

To buttress his point, the expert adds that fund asset size being a constraint for performance is a myth. Let’s examine this hypothesis. In India, the framework for expenses charged to a fund is structured to reduce cost when asset size grows. Hence, the larger a fund gets, cheaper it becomes; this is certainly positive for investors. Also for debt funds, it might help to have a larger size to enable making investments in government securities, given the standard market lot size of Rs 50 mn.    

But there is a flip side too: A large fund size can pose challenges in the form of market-impact costs, the opportunity cost of having to spread trades over longer periods and liquidity management; this is especially true in small/mid-cap funds. In India, several small/mid-cap funds have mutated into large-cap dominated funds thanks to unrestricted asset flows. It’s worth mentioning that in many cases the performance in the new avatar was a shadow of its former self.

Finally there’s the often unappreciated fact that the dynamics of running a large fund are vastly different versus those of running a smaller sized fund. Not every portfolio manager has the skills to successfully run a large fund. 

Why investors must beware

There’s a plethora of investors who are yet getting used to the idea of investing in mutual funds. Sadly, misconceptions such as invest based only on performance, focus on the one-year showing are prevalent. When oblivious experts go about preaching that a large asset size aids performance et al (in other words, ‘invest in a large sized fund’) they are doing investors a disservice. On their part, investors would do well be wary of such experts and their advice.

Data sourced from: www.bseindia.com

3 equity funds you shouldn’t give up on...

From Jan 2014 through June 2014, the S&P BSE Sensex has risen by 20%, while the CNX Midcap index has appreciated by 37%. As with every market upturn, this time around too, the performance of equity funds has come under the scanner. There are several articles doing the rounds, detailing which equity funds and fund categories have fared the best. Keeping with the norm, the investing community has yet again displayed little tolerance for funds that have failed to make the most of rising markets. As a result, funds that have underperformed (relative to peers and/or benchmark indices) are being vociferously scorned.

I thought it will be interesting to focus on 3 equity funds that haven’t had an impressive run thus far, but continue to be strong offerings, nonetheless. To be clear—I’m not suggesting that six months is an adequate time period for evaluating equity funds; neither is that a recommended investment horizon.

However, the fact remains that there is a lot of short-term oriented advice and views doing the rounds. Investors can and do get influenced by such erroneous advice. If anything, this commentary is intended at refuting such short-term views. Here’s a checklist of 3 equity funds that investors shouldn’t give up on.

1. Franklin India Bluechip Fund

It has been a tough ride for the fund, thus far in 2014. On a year-to-date (YTD) basis ending June 2014, the fund (up 21%) has marginally outscored its benchmark index (S&P BSE Sensex) by one percentage point. In a peer-relative sense (i.e. versus large-cap funds), the performance has been found wanting. Here’s why: to begin with, manager Anand Radhakrishnan adheres to the fund’s large-cap nature far more stringently than the category norm; in the present market upturn, small/mid-caps have outscored their large-cap peers. Also, the manager’s top-picks Infosys and Bharti Airtel have detracted from the fund’s performance.

Why you should keep the faith:      

The fund has all the makings of a top-notch offering. Supported by an accomplished investment team, Anand ranks among the best portfolio managers in the country. The investment process is robust—research-driven with an unwavering focus on quality and reasonably valued stocks. The benchmark-agnostic approach coupled with willingness to trade-off short-term pain for long-term gains, only further accentuates the likelihood of a divergent showing versus the norm, in the near-term. However, over the long-haul, the fund remains ably equipped to reward investors. Finally, it helps that the fund is backed by one of best fund companies in the country.

2. DSP BlackRock Small and Mid Cap Fund

Manager Apoorva Shah hasn’t had the best of times in the recent past. In 2013, funds helmed by him had an eminently forgettable year; among other reasons, Shah’s bet on a macroeconomic turnaround didn’t quite come off. As for this fund in particular, despite having bested its benchmark (CNX Midcap) both in 2013 and thus far in 2014, it has failed to match the showing clocked by a typical small/mid-cap peer. In the Jan 2014-June 2014 period, Shah’s investments in a motley mix of stocks such as IPCA Labs, Persistent Systems and Britannia Industries have held back the fund.       

Why you should keep the faith:     

Not many managers can match Shah when it comes to skilfully combining fundamental factors (such as an in-depth understanding of stocks) with elements such as market sentiment and news flow. The investment process though not robust in the conventional sense, is certainly workable. It helps that the manager is at home with the process, and executes it with skill. Over the years, Shah has displayed the ability to rapidly realign the portfolio and recover lost ground. Another factor in the fund’s favour is the fund house which ranks among the better ones in the industry. All in all, the fund continues to be a strong long-term bet.

3. SBI Magnum Global Fund

A cursory glance at this fund’s recent performance might lead one to believe that manager R. Srinivasan has lost his touch. YTD ending June 2014, the fund has appreciated by 31%, and underperformed the S&P BSE Midcap index by nine percentage points; on the peer-relative parameter, the fund fares even worse. Interestingly, while the manager’s top-picks have by and large fared well, select holdings from the financial services, media and health care sectors have taken away from the fund’s showing.

Why you should keep the faith:     

In the small/mid-cap segment, few managers can hold a candle to Srinivasan. The manager relies on intensive research to ferret out growth stocks. The emphasis on business competencies further underpins the process. Over the years, he has displayed an uncanny ability to pick winners ahead of the curve. Another positive is Srinivasan’s willingness to back his conviction bets, and adhere to the fund’s small/mid-cap nature. At an asset size of INR 10.7 billion (as of June 2014), capacity—a typical area of concern in small/mid-cap funds—isn’t a worrying aspect as yet. The fund’s long-term credentials remain untarnished.

On a concluding note, just as near-term underperformance doesn’t dent an inherently strong fund’s long-term prospects, a strong showing clocked by a mediocre fund on the back of rising markets, doesn’t enhance its long-term prospects either. Be wary of such short-term wonders.

Data Source: Websites of fund companies, www.bseindia.com, www.nseindia.com

HDFC Top 200: An underrated achiever

Did you know that even investments can be exciting? Typically, asset classes or investment avenues that have hit a purple patch make the grade as exciting ones. Especially, the ones that have gone from obscurity to prominence in a short time span. They are written about in the media and instantly recommended by investment advisors. For instance, a fund that has delivered a trail-blazing performance and is perched at the top of the rankings. Even providers of financial services enjoy their fifteen minutes of fame; say a fund house that holds the largest asset size in the industry. Don't get me wrong. There is nothing wrong with an asset class, an investment avenue or a financial service provider being lauded and discussed, because it has delivered. In fact, it's only to be expected.

The trouble starts when one reads too much into the 'exciting' bit and makes investment decisions based solely on the same. Also, since most of the fanfare can be attributed to a recent showing, it is difficult to distinguish a 'flash in the pan' from a 'sustainable' performance. And for serious investors, the latter is certainly a more important evaluation parameter.

Then there are funds which don't qualify as exciting ones. Make no mistake, that's not the same as being non-performers. On the contrary, these can be funds that go about playing their part to perfection, but in an understated manner. They often deliver with enviable levels of consistency. Their performance over longer time periods and across parameters can be impressive. Despite this, there is never a frenzy surrounding them. It is not uncommon for such funds to be labelled as 'boring'.

Sadly, most investors fail to realise that in the context of investing, boring can be good. This is because, boring translates into predictability. And predictability means fewer unpleasant surprises. If you are building an investment portfolio to achieve certain objectives, boring funds of the aforementioned variety should account for a lion's share of the portfolio. The fact that a fund isn't in the limelight or isn't perceived as exciting is no reflection on its prowess. A competent performer stays the same irrespective of the attention it garners. HDFC Top 200 Fund (HT2F) is one fund that falls in the category of underrated achievers.

Originally an offering from Zurich India Mutual Fund, the fund became a part of HDFC Mutual Fund subsequent to the former's takeover in 2003. A diversified equity fund, HT2F's investment proposition is quite simple. It largely invests in stocks of companies featuring in the BSE 200 index. An interesting aspect of the fund is that it combines the active and passive styles of investing. It holds around 60% of its portfolio in line with the BSE 200 index. The fund has also benefited from the presence of its fund manager, Prashant Jain (Executive Director & CIO-HDFC Mutual Fund). Incidentally, Prashant Jain was earlier associated with Zurich India Mutual Fund. The fund's long-standing association with the fund manager has served it well.

Now for the performance. For a fund that has been in existence for well over a decade (inception in 1996), HT2F's track record is impressive to say the least. As on July 14, 2009, over the 3-Yr and 5-Yr periods, it had delivered 17.5% CAGR and 31.2% CAGR respectively; the corresponding figures for BSE 200 were 9.9% CAGR and 21.8% CAGR. Over the last 12 months, the fund posted a growth of 22.3% vis-à-vis just 3.1% for its benchmark. HT2F's NAV rose by 21.6% CAGR over a 10-Yr period as compared to 13.8% for BSE 200. And that is no mean achievement!

Any analyst worth his salt will agree that a fund's mettle is truly tested during a downturn. In recent times, after peaking in January 2008, domestic stock markets went into a downward spiral that lasted until March 2009. Over this (approximately 14-Mth) period, between it highest and lowest points, the BSE 200 shed 64.9% on an absolute basis; HT2F scored over its benchmark by losing 54.8%. In effect, the fund has fared better than its benchmark in both the upturn and downturn. HT2F is no laggard when it comes to competing with peers. Its showing vis-à-vis comparable peers (funds that predominantly invest in the large cap segment) is equally noteworthy.

Despite this, there is no perceptible buzz around the fund. No one is raving about its performance. This is hard to explain. For some obscure reason, HT2F lacks the 'X' (read exciting) factor that is much needed to draw attention.

What investors must do
For one, it would help if you don't let the hype or 'lack of it' affect your investment decisions. Always remember, investing need not be exciting; conversely, as mentioned earlier, boring can be good. You must check with your investment advisor/financial planner if a competent and proven, yet seemingly humdrum fund fits in your scheme of things. And if it does, by all means get invested.

(NAV data sourced from www.hdfcfund.com; data for BSE 200 sourced from www.bseindia.com)