Insights

2017 – When mixing strategies paid off for our Select Funds

December 20, 2017 . Mutual Fund Research Desk

After a frustrating 2016, the markets threw caution to the wind in 2017 and lifted many stocks whose names were last heard in the pre-2008 rally. While mutual funds too made the best of the upswing, many funds did lag benchmark indices in 2017. They did so either because they were uncomfortable owning too much of the rallying stocks as valuations looked steep, or the stocks were merely momentum plays that would not fit many a fund’s criteria in terms of fundamentals.

FundsIndia’s Select Funds marginally beat indices in the equity space and convincingly beat them in the debt space, despite the latter facing a tough year.

Before we move on to this calendar review, we would like you to know that the calendar year performance is more to elucidate what kind of a year the market faced and what funds did and to let you know how we mixed our strategies to deliver. Such short-term performance should not be considered to judge funds or make decisions on buying and selling.

Hence, to not lose sight of longer period returns, here is a table to illustrate how our funds have done over a 3-year period.

3-year returns of FundsIndia's Select Funds
FundsIndia Select Funds - Equity- Moderate risk13.10%FundsIndia Select Funds - Debt - Short term8.50%
S&P BSE 1008.90%CRISIL Short Term Bond Fund Index8.30%
Equity large-cap category average10.50%Debt short term category average7.80%
FundsIndia Select Funds - Equity- High risk18.40%FundsIndia Select Funds - Debt - Long term8.90%
Nifty 50011.00%CRISIL Composite Bond Fund Index8.90%
Equity multi-cap & mid-cap category average14.40%Debt long term* category average8.00%
*Dynamic bond, income, and credit opportunities categories.
Returns as of Dec 11, 2017. Returns are annualized. The returns are for Select Funds list as of Dec 11, 2017.

The returns are also a reminder that over the long-term, consistency pays off over flashy returns. While you may see the 1-year performance of our Select Funds yo-yo a bit, the longer period returns tell you that picking steady performance over top performers is a sound strategy.

2017 performance

Equity funds – Moderate risk:  This category has a mix of pure large-cap funds and those with a large-cap focus. We use S&P BSE 100 as a benchmark for this category as it is a stiffer one to beat than the Sensex or Nifty 50. For the calendar year up to December 11, 2017, our moderate risk category beat the index and the category average by about 1.5 percentage points. This outperformance was not an easy one as you will see that the category could not beat the BSE 100 index. What yielded better results was a mix of strategies. For instance, Franklin India Bluechip or an SBI Magnum Equity were pure large-cap funds and did not budge in terms of taking higher exposure to midcaps even as the latter outperformed. Others such as Invesco Dynamic Equity took cash calls as markets grew expensive. Individually, these funds did not beat the index.

But our list held funds with focused strategies, where stock-specific calls or sector-focused approach worked very well. We did not also want to lose out on opportunities in the US and added a fund like Parag Parikh Long Term Value, that delivered well in quarters when Indian markets lagged. When we built this category list, we thus brought in a mix of stable large caps, and funds with more focused approach to large-cap stocks or focused approach to sectors and a bit of value and international strategy.

Returns (Calendar year up to Dec 11, 2017)
FundsIndia Select Funds - Equity- Moderate risk30.20%
S&P BSE 10028.80%
Large-cap category average28.70%
FundsIndia’s Select Funds with quarterly changes made. Returns are point-to point up to December 11, 2017.

And yet, our outperformance was thin for a few reasons: one, some of the funds from the UTI and BNP Paribas house that were in our watchlist dragged performance. We had to wait to see if these funds would turnaround. While they did make some progress, in runaway markets such as 2017, it is hard for such turnaround candidates to catch up. The second reason the outperformance was thin is the constituents of the S&P BSE 100 and what they delivered. Mutual funds had turned a bit wary of NBFCs and had reduced exposure to them even while these stocks continued to be the top performers in the index. Similarly, real estate was one space which most funds were uncomfortable taking exposure to or took an insignificant exposure. These factors resulted in the lacklustre performance of portfolios. Added to this, some of the funds we have in this category have also taken contrarian bets, whether in IT or pharma, thus pulling down short-term returns.

Equity funds – High risk: This category is a mix of funds that are either mid-cap funds investing more in the higher end of the market-cap segment or diversified funds with an aggressive strategy. We, therefore, find it more apt to compare this category with the Nifty 500, although we have given the performance of the Nifty Free Float Midcap 100 index as well.

We must admit this has been an extremely difficult category to handle for us. For a category which we do not recommend as a chunk of any portfolio, our approach here has been to look for optimal returns with lower volatility. While that has come by, the fund performances have been too divergent to offer any cogent explanation on where they did well or did not as a portfolio. However, we can take individual funds to explain.

Returns (Calendar year up to Dec 11, 2017)
FundsIndia Select Funds – Equity - High risk34.00%
Nifty 50032.20%
Nifty Free Float Midcap 10040.20%
Equity multi-cap & mid-cap category average34.40%
FundsIndia’s Select Funds with quarterly changes made. Returns are point-to point up to December 11, 2017.

Funds such as Mirae Asset Emerging Bluechip or L&T India Value have been steady outperformers here, while funds that remained cautious on valuations like Franklin India Prima or HDFC Mid-Cap Opportunities saw a less convincing performance. Others such as ICICI Pru Value Discovery that went totally contrarian suffered. If that is on the fund side, our funds also had to contend with a challenging mid-cap category. With more small-cap funds moving towards mid-cap stocks, we are having to classify them as midcap funds. But then these still carry a robust return record from past quarters that makes them seem superior to our high-risk Select Funds category. This, of course, is merely a classification issue and should normalise over time.

What is more worrying is where the returns of the broader index Nifty 500 have come from. A whole lot of small company names, with valuations not supported by earnings and a host of brokerage stocks, realty stocks and trading companies have seen a massive rally, with some generating multi-bagger returns. We don’t think we’d be comfortable with funds holding those kinds of stocks to generate returns at any cost. To us, it is better safe than sorry even when we term a category high risk. That the high-risk category generated 4 percentage points over the moderate-risk space, to us, is good enough a sign that the extra bit of risk delivered.

Having said that, our misses here came in the form of underperformance in UTI Midcap, which underwent a portfolio tightening post fund management changes. Like we mentioned earlier, no amount of restructuring can help catch up in a wild market. Others such as SBI Magnum Midcap too underperformed despite a portfolio of fundamentally sound stocks. But the fund appears to be turning the corner in the last few months. We also made the mistake of being a bit hasty in this category when it came to putting funds on watch. Funds such as Franklin India High Growth Companies tested our patience with underperformance due to telecom exposure. But it took less than a quarter for the fund to bounce back with SBI and Bharti Airtel stocks paying off. But we were off this fund by June after several quarters of watch and its absence hurt us. Aggressive funds just need one or two ideas to drive their returns and this is a classic example of such ideas, albeit contrarian, paying off. Although we removed the fund from our list, we had specifically said investors should continue their SIPs and hold the fund.

Debt funds – Short term: Debt as an asset class saw a rollercoaster ride in 2017. While the returns remained enviable for many parts of the year, the run-up in yields in the last few months dragged returns to the sub-7% mark for many categories under debt. We will discuss more on what we feel about this development in our outlook for 2018 that you will receive in January 2018.  But within the constraints that the asset class posed, our funds did a good job.

Returns (Calendar year up to Dec 11, 2017)
FundsIndia Select Funds - Debt - Short term6.50%
CRISIL Short Term Bond Fund Index6.30%
Short-term debt category average5.90%
FundsIndia’s Select Funds with quarterly changes made. Returns are point-to point up to December 11, 2017.

Having observed short-term debt funds take high duration calls or take excessive credit exposure, we can pride ourselves in terms of the tight norms we built for rating funds in this category. We wanted less volatility, optimal returns, and limited downside given the short-term period for which investors enter this category. The discipline we adopted helped generate superior returns, even beating the index, a rare phenomenon in debt.

A mix of banking and PSU funds, high-quality accrual funds and a few with steadily declining maturity calls helped this category beat the category average comfortably with risks far lower than the category.

Debt funds – Long term: In this category, we have, for over 2 quarters now, been voicing our view on going for an accrual strategy and giving limited exposure to duration strategy. Here again, our view paid off but as investors, you are unlikely to be happy with the returns you see at present, as they have dwindled to FD-returns. The 2 dynamic bond funds in our list pulled down returns even as accrual funds remained largely steady. Of the dynamic bond funds, Aditya Birla Sunlife Dynamic Bond fund did fall the most because of its aggressive duration call. With a fund manager who has seen many interest rate cycles and bounced back well in the past, we felt providing time for the fund’s view to work was necessary. But we are cognisant of the inflation risks and what they can do to interest rates. We will, therefore, take calls on the dynamic bond space based on whether funds change their strategies from here on.

Also, you need to keep in mind that these funds require a 2-3-year strategy and are not devoid of risks. Hence, to exit or book losses within a year may not be a prudent strategy if the category itself is going through a down phase. Worse still, to exit from debt to equity because the latter is delivering well may be risky. We will review the funds in our quarter-end Select Funds review and provide our outlook for debt in January 2018.

Returns (Calendar year up to Dec 11, 2017)
FundsIndia Select Funds – Debt - Long term6.10%
CRISIL Composite Bond Fund Index4.90%
Debt long term category average*5.40%
FundsIndia’s Select Funds with quarterly changes made. Returns are point-to point up to December 11, 2017.
*Dynamic bond, income, and credit opportunities categories.

Summary

Overall for us, 2017 was a better year as we made fewer mistakes and showed better discipline, especially in debt. It is important for you not to get swayed or dismayed by 1-year performance. Please check with your advisor for any specific queries on fund performance.

We will, in the next few weeks, let you know what 2018 holds for your funds and what your strategy should be. Irrespective of what we say, the bigger truth remains this: “Investing should be like watching paint dry or watching grass grow. If you want excitement…go to Las Vegas.” – Paul Samuelson.

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Wish you a very happy and prosperous new year!

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