Choosing Funds Based On Long/Medium-Term Performance

KEY POINTS:

• It is a classic dilemma as to whether the investor should focus on long-term performance or medium-term performance to judge a fund. An examination of the portfolio that the fund holds in comparison with its peer group at present and in the recent past is a must.
• It would be very difficult to shake off a long track record of success and judge the fund based on its three-year performance. The only way out in such a dilemma is to be diversified and have a choice of funds in the category.

I have been investing in HDFC Equity Fund, a top rated fund, since 2010 but am not happy with its performance. Please advise me as to what I should do.

- Taher Fahim

It cannot be denied that this fund has set up high expectations for investors due its commendable track record over many years now. It is among the largest in its category, with Assets Under Management (AUM) of around INR 10000 crore. It also has the distinction of having had the same fund manager since the inception of the fund in 1995.

HDFC Equity Fund’s long-term performance has been among the best in its category, with a high alpha added by the manager. While its 10-year performance is a fantastic 21 per cent compounded per annum and ranked second in its category, its one-year and three-year performances are far from inspiring. It has slipped from being a five-star rated fund to being a three-star rated fund. The divergence in performance from its peer group increases in the three-year to one-year performance as compared to its five-year performance.

It is a classic dilemma as to whether the investor should focus on long-term performance or medium-term performance to judge a fund. Statistics alone may not help you to make this decision correctly. An examination of the portfolio that the fund holds in comparison with its peer group at present and in the recent past is a must.

On making a closer study, it becomes apparent that some of the calls taken by the fund’s manager have not panned out as expected. Initially, the large holdings in banking and in particular some PSU banks did not work out. Though they presented value, the value has not unlocked even after so many years! While the market has been driven by a few stocks belonging to the FMCG, pharma and consumption-led industries, most of the good ones are overpriced and hence have been avoided by the fund manager. This too has led to underperformance, while some managers played on momentum.

Largely, the conviction by the manager in his portfolio is apparent, with the fund enlarging its position in some of the stocks over the last few quarters and averaging the price. But unfortunately, apart from the last 30 days, the fund has not been able to recover its performance. It is quite likely that it would get back its shine only with broad economic recovery, when the stocks in this portfolio would shine, and very brightly!

It would be very difficult to shake off a 15-year track record of success and judge the fund based on its three-year performance. The only way out in such a dilemma is to be diversified and have a choice of funds in the category. What typically happens, though, is that that the investor knowingly or unknowingly takes an additional risk in his/her pursuit of additional returns.