Shining Mutual Funds Stars

"Wall Street people learn nothing and forget everything," said world-renowned investment guru Benjamin Graham. This applies not just to Wall Street, but also to Dalal Street as well, and also to all other stock markets across the world! People burn their fingers and forget about it, only to pass through the fire again! The tech boom and bust in 2000 saw investors who had heavily invested in technology stocks burn their fingers badly. More recently, the Indian realty and banking stocks took a huge beating. Yet, people will come back, only to get beaten again. Which begs the question: Is the market a safe place to invest at all? Well, it's certainly not for the risk-averse investors. But if such investors wish to invest in the market, they have the option to invest through mutual funds. Mutual funds invest in the stock market, but the question that retail investors face is: which mutual funds should they invest in?

For most of the mutual fund investors who invested since January '08, the experience has been rather disappointing. It was hard to digest the dwindling value of their investments. Since June 2003, the market knew no other direction other than north and there was hardly any major bear phase (except for the temporary blip in May 2006). But since January '08, the market has gone for a toss and tested the patience of the most steadfast investors.

Mutual Fund Industry
The jittery state of market notwithstanding the mutual fund industry in India has come a long way since 1964 when UTI launched the first MF scheme US-64 in India. The assets under management (AUMs) have increased exponentially from Rs 6700 crore in 1988 (when the monopoly of UTI was broken and other banks entered the mutual fund industry) to Rs 6 lakh crore in May 08. According to the latest Association of Mutual Funds of India report, there are 36 asset management companies (AMCs) operating in India managing Rs 5.3 lakh crore as on 31 July 2008. There has been a drop of seven per cent from the month of January when the total AUMs was Rs 5.7 lakh crore. In the last one year, AMCs have seen their corpus increasing by 14 per cent, which is dwarfed by the 50 per cent increase in AUMs that these AMCs witnessed in the year 2006-2007.  If we analyze individual AMCs, we find that DBS Chola and Baroda Pioneer saw steep fall of 51 per cent and 44 per cent in their AUMs, whereas Canara Robeco and Birla Sun Life saw major increase in their AUMs to the tune of 46 per cent and 17 per cent, respectively from July 07 to July 08. Three new AMCs have started their operations during the last six months and are currently managing Rs 14,500 crore. Currently, there are about 270 equity diversified funds, out of which only 120 have history of more than three years. The average performance of equity diversified funds has outperformed all other type of funds, including banking (equity), debt-oriented funds, etc., in the 3-year time-frame. For example equity diversified funds gave return of 17 per cent and debt liquid plus and equity banking gave return of 7.2 and 12.95 per cent respectively in three year time frame. To select the best of the funds from equity diversified, we developed in-house procedure to pick funds which not only have history of good performance but are likely to perform well even in future (See Box: Methodolgy).

Why Equity Diversified Funds?
There are umpteen number of mutual fund schemes to choose from, making the task of selecting the right scheme difficult for retail investors. So we took it upon ourselves to do the task on their behalf and recommend a bouquet of funds. The thematic funds perform well in rising market but diversified funds are best suited in falling market or when market starts recovering. Sector funds do well in short run and are short lived in their performance. They do well only when the sector is performing well. For example, last year the realty funds did exceeding well and gave returns of more than 70 per cent, but this year they were the culprits who led to the sharp drop in the portfolio value of investors. Sectoral funds suffer from the cyclical nature of the sector and do well only when that sector performs. To benefit from them, investors may be required to time the market, which even the most seasoned investors cannot achieve.

According to our research of more than 600 funds in different categories and different time periods, equity diversified funds have come out distinctly ahead in creating wealth for investors in the long-term. These funds do not suffer from the seasonality of the sector funds. With proper allocation, these funds can even benefit from boom in any sector. Therefore, we decided to focus on funds which can be all weather funds and maximize the wealth of investors in long run and found that equity diversified funds fulfill these criteria best. After zeroing on the best type of funds, we shortlisted the best equity diversified mutual fund schemes through a rigorous process of selection and picked up the best 7 among the lot.

The Top Performers
The top performer during the trailing last three years was DWS Investment Opportunity, which gave a superb annualized return of 29.23 per cent, followed by Sundaram BNP Paribas Select Focus which gave 28.45 per cent return. Reliance Growth scheme, which appeared in our last year ranking also, was ranked 15th based on its three year performance, but since it performed well during the last one year as well as six-month time period, it qualified among the Top seven funds (during last six months, it fell by 17.93 per cent and in one year's time, it grew by 4.34 per cent). Our last year portfolio performed in line with the market and three out of seven funds have outperformed the market. (See table: Last Year Performance). So, here are Top 7 mutual fund schemes which in our view are expected to perform well even in a falling market.

Reliance Growth
Who says that an elephant cannot dance? It can do so and when it does, everybody sits up and takes notice. Reliance Growth is like a big daddy of elephantine proportions in the sphere of equity diversified funds, having a corpus of more than Rs 4,700 crore. This big corpus amount has helped the fund to keep its expense ratio below two per cent. (Average expense ratio for equity diversified funds is 2.12 per cent). Since its inception in October 1995 the fund has given annualised return of 30 per cent and is managed by Sunil B Singhania. If we take last year in perspective when the market has yielded a negative return of six per cent, this fund is found to have done well and given a return of 4.34 per cent. This performance has been noticed by the investors and can be seen in their increase in its corpus size. It increased to Rs 4,792 crore (31/07/2008) from Rs 4,080 crore last year, same day.

The fund was able to maintain its performance due to its timely allocation of funds to the defensive sector and reduction of exposure to ferrous metals. It increased its exposure to the pharma sector to 7.98 per cent (31/07/2008) from 6.7 per cent in January 2008 and consumer non-durables from 2.59 to 3.79 per cent in the same time period. The fund reduced its exposure to ferrous metals from 12.44 per cent (31/07/2008) to 7.29 per cent (31/01/2008). One of the most important strategies that the fund manger has adopted is to increase its cash component. It increased from 12.68 per cent in January 2008 to a whopping 27.68 per cent in the latest fact sheet (July 08). A larger cash holding will give the fund manager the flexibility to pick quality, beaten down stocks.

The fund has the objective of achieving long term growth of capital by investing in small, mid and large cap stocks. This helps the fund to be more diversified than its peers. The top five sectors constitute 29.77 per cent of the total portfolio and the top ten holdings of the company contain 28.52 per cent in total assets. As a whole, in this volatile market when no clear trend has been emerging to the fore, adding Reliance Growth fund to the portfolio provides the much required stability.

Deutsche Alpha Equity
The market has sharply fallen in the last six months and investor's main concern has been saving their portfolio from heavy erosion. DWS Alpha has succeeded in this objective. Looking at the year-to-date returns, the fund's peers have fallen by 35.64 per cent, the fund's benchmark S&P CNX Nifty has given a negative return of 30.08 per cent, while DWS Alpha Equity has minimized downturn with negative return of 29.15 percent. The fund is managed by Aniket Inamdar since June 2007, who also manages the DWS Investment Opportunity, which has performed well confirming the deftness of the fund manager.

The fund predominantly invests in large cap companies with relatively fewer numbers of stocks having comparatively better potential. The fund has successfully outscored its benchmark as well as the category returns since its inception. The fund has performed consistently with low volatility (standard deviation of 29.81 per cent) with higher returns per unit of risk (Sharpe ratio of 0.85 percent against 0.58 percent of average).

The fund has been regularly churning its portfolio envisaging volatility in the market. The fund is overweight on capital goods and natural resources and this has worked well as did a number of bottoms up picks. The fund's focus on investing in quality stocks helped it during the market declines in the first half of 2008. The fund was also underweight on interest rate sensitive sectors like real estate, PSU banks, auto which helped it to perform well. Looking at the fund's portfolio, it is clear that the fund is currently overweight on power equipment sector, which is expected to have excellent growth prospects and is unlikely to be impacted by a slowdown. The fund has reduced weightage in metals sector while increasing its weightage in the FMCG sector. At the same time, it has increased its holding in the software sector where the returns are stable and downturn is limited as compared to the other sectors. The current buzz on the government move to bail out the fertilizer sector from its fund crisis has seen Deutsche Alpha accumulating fertilizer stocks (Tata Chemicals) in the last three months. Looking at the proactive strategy of the fund to create value for investors, one can buy for better returns.

Sundaram BNP Paribas Select Focus Regular
Sundaram BNP Paribas Select Focus Regular has remained one of the best performing equity diversified funds. It has remained consistent performer, giving annualized return of 28.64 per cent in the last three years. Even in short duration of one year, it has outperformed the market by huge margin. It gave annualized return of 8.35 per cent in last one year, compared to negative return of 6.63 per cent by market. This led to increase in corpus size from Rs 701 crore to Rs 924 crore. When asked about the strategy being adopted to give this alpha returns, Srividhya Rajesh, Fund Manager, said "The fund's strategy is to identify three themes with a 18-24 month outlook, based on a top down analysis of macroeconomy and then invest around 75 per cent of the fund in them"

The sector which currently dominates fund now is energy, telecom, IT and metals, which form 45 per cent of the total portfolio. The fund has major holdings in Reliance Industries, ONGC, Sun Pharma and Bharti Airtel. It has a tilt towards defensive sectors to cushion against rising interest rate. It has reduced its exposure in financial services from 14.9 per cent in January to 7.8 per cent in July. Though the fund shows aggressiveness and invests 90-95 per cent in equity, it has shown less aggressiveness in recent times due to change in market condition. It is sitting on cash and cash equivalents to the tune of 23.4 per cent. This has increased from 19.2 per cent in January. The fund invests in 30-35 stocks large caps stocks. The current PE of portfolio is 15.32 is lower than the market PE of 18.77. This limits the downside of the fund and hence it is expected to perform better in a falling market.

Seeing the strong performance and perfect strategy to ward off slowdown (investment in large cap, large cash holding, lower PE than market), we recommend our readers to enter the fund with a long-term horizon.

ICICI Prudential Dynamic
As the name suggests, the fund is dynamic as the asset allocation pattern permits the fund to invest 0-100 per cent in equities and debt without any bias in value and growth, large and midcap, index and non-index. This fund has formed a part of our recommendation on account of its remarkable returns not only in the long run but also in the short run. Since its inception, the fund has consistently managed to beat the category returns as well as the benchmark index (S&P CNX Nifty) with a huge margin.

In the last three years, the fund has managed to give 25.24 per cent returns while the one year returns stood at 0.96 per cent. Even in the last six months, the fund has managed to minimize the downside and gave negative return of minus 11.33, while the category return stood at minus 21.31. The fund has been able to put up such a commendable performance taking minimal risk. This is quite evident from the fund's Sharpe ratio, the risk adjusted returns, which stood at 0.86.

According to the fund manager, S Naren, "In the year 2005 and 2006, the fund outperformed because of good bottom up stock picking. Although in 2007 the fund underperformed, 2008 has seen  the  fund  again  deliver  strong  performance  on  account  of being underweight  in  sectors  like  banking, utilities, real estate and capital goods  in  the  first  quarter of the year".

Currently, technology and energy are the top two sectors where the fund has invested 19.36 and 13.43 per cent of its portfolio, respectively. In the current economic environment, the fund is bullish on sectors like consumer non-durables and health care as these sectors are not only good defensive bets but also the valuations in these sectors have been attractive.  Recently, the fund has reduced its exposure to capital goods on account of its expensive valuations.

Currently the fund is wisely sitting on cash of 10 per cent of the portfolio which will be invested on incremental basis as and when there is an opportunity. Due to the excellent past track record of this fund as well as the fund manager, we suggest investors to invest in this fund.

Templeton India Growth Fund
Templeton India Growth Fund's (TIGF) philosophy of investing in 'value' stock is paying off now. Though it lagged in its performance during 2006 compared to its peers when 'growth' stock stole the show, it rose like the proverbial Phoenix and outperformed its peers during 2007 and 2008. In 2006, when the market gave an absolute return of 48 per cent, the fund was able to generate only a 30 per cent return. This changed in 2007 and year-till-date (YTD). In CY07 when the market gave an absolute return of 46 per cent, the fund gave a return of 63.1 per cent and YTD it fell by 25.68 per cent compared to the market failing by 33 per cent. This performance helped the fund to give an annualised return of 23 per cent in three years and become part of our shining stars.

The fund was able to generate this type of return due to its timely allocation of funds in ferrous metals in 2007 and software in 2008. In 2007, the fund was able to capture the rally in ferrous metal with a major holding in Tata Steel, Sesa Goa and SAIL. In 2008, the company rightly increased its exposure to the software sector which helped the fund to contain its fall. The fund invests in both large caps and mid caps. TIGF has AUM of Rs 330.61 crore and its portfolio consists of only 32 stocks. The fund has maximum exposure in petroleum products, ferrous metals and finance. They constitute 37.75 per cent of the portfolio. The top ten holdings constitute 59.28 per cent of the total holding. The fund's major holding is in Reliance Industries, ONGC and Tata Investment. Cash position in only 2.17 per sent in portfolio.

As market sentiment has turned down and investors are becoming more averse to risks we recommend our readers to invest in this fund due to its focus on investing in value stocks.

HSBC Equity
HSBC Equity fund is one of our top recommendations on account of its astonishing performance since its inception. The fund has managed to give impressive returns in the long run with its 3 year and 1 year returns at 23.71 per cent and 5.64 per cent respectively, beating its benchmark returns of 17.42 per cent and minus 6.63 per cent, respectively, for the same period. In the last six months, the fund gave returns of minus 17.86, while the category returns stood at minus 21.31. Thus in short term, the fund has managed to minimize the losses as compared to its category.

The fund is positioned as large cap actively managed diversified equity fund with focused portfolio of about 35 to 40 stocks and 80-85 per cent of the portfolio invested in large caps. Considering the low risk taken by the fund, it is quite remarkable for the fund to put up such a performance. The fund has investment philosophy of business cycle investing, wherein depending on the fund house view on the global and local business cycles, the fund takes the sector and asset allocation calls.

The main reason behind the success of the fund is the accurate sectoral calls. These include the reduction in the fund's exposure to auto sector in early 2007, the overweight on the infrastructure sector in 2006 and 2007, reduction of the exposure in the IT sector in 2007 and, lastly, increase in exposure in FMCG, IT, energy, and cash levels in early 2008. Its exposure to the IT sector stands at 14.96 per cent of its portfolio.

Mihir Vora says, "Broadly we believe that infrastructure-linked sectors and consumption-oriented sectors may continue to do well. This means in the medium term, we might be bullish on engineering, capital goods, construction, telecom, housing finance, FMCG, cars, etc."

The fund is astutely sitting on cash of nearly 20 per cent. The fund manager has been able to take the accurate sectoral call on consistent basis,  thus investors can buy the fund for long term investment horizon.

DSP Merrill Lynch Top 100 Equity
DSP Merrill Lynch has remained one of the top performers among its peers. The fund launched in February 2003 has given consistent returns. It gave annualized return of 41.75 per cent since inception and 29.38 per cent in the last three years. In the shorter duration also, it has outpaced its benchmark, giving a return of six per cent for one year and negative return of 30 per cent in the last six months.

As the name goes, the fund invests in top 100 listed companies by market capitalization. In this volatile market, this gives stability to the fund. The fund has a Sharpe ratio (refer glossary for definition) of 0.92, which is one of the best among its peers (which have an average ratio of 0.58) as greater the ratio better the risk adjusted return of the fund.

The fund is managed by Apoorva Shah since last two years. Currently, the total net asset managed under the scheme is Rs 957.56 crore. The fund has invested more than 90 per cent in equities,while the cash component is less than 10 per cent, which has remained almost same since last eight months. The fund has cut its exposure in the banking and industrial capital goods sectors since January this year. The banking sector now constitutes 9.6 per cent of its portfolio compared to 20.54 per cent in January. The fund has increased its exposure in pharmaceuticals from 2.59 per cent to 9.6 per cent in the last eight months. One of the strategies the fund is adopting to beat the volatile market condition is to increase its position in index futures. It has increased exposure in index futures from 8.33 per cent to 16.32 per cent in the last eight months. It has increased its holding in Bharti Airtel and HDFC, while reducing its holdings in SBI and ICICI Bank. The fund has also reduced the number of scrips in its portfolio from 45 to 40 in the last eight months. We believe that the fund would continue to give excellent returns in the next couple of years and recommend our readers to invest in it.