Changes to FundsIndia’s Select Funds

January 16, 2019 . Mutual Fund Research Desk

These are hard times for equity and cautious times for debt funds. But what we can tell you is that funds in the Select Funds list have weathered volatile times in the past and have pulled through with market-beating performances.

Our additions to the Select Funds list this quarter are minimal. We have been stricter with removing some funds, but we have also been circumspect with other seeming under-performers since experience has taught us that these have the capacity to bounce back and reward patience.

Apart from the US Federal Reserve’s rate hike path (it only recently moderated its stance), trade wars and the swinging crude price, on the domestic front, uncertainty stemming from state election results and the liquidity crunch in the NBFC space, pulled down equity market sentiments. Markets also contended with volatility in the rupee. In this scenario, bear in mind the following:

• The index numbers belie the broader market trends. The broader stock market has corrected, as we have said before. Of the BSE 500 index, 75% is in losses on a 1-year basis. Some sectors have been hit much harder than others. To this extent, fund performances will be much worse off than the Sensex or the Nifty 50 numbers imply.

• Funds’ differing strategies affect returns. Some can see opportunities in smallcaps and midcaps, others could see buying in beaten down sectors, and others play it safe. For funds viewing markets from a longer perspective, the correction has offered buying opportunities. Several funds have picked up cyclical sectors such as construction, banks, mining, metals, petroleum products, power. Some have picked up telecom, automobiles or pharmaceuticals. Exposure such as this has dealt a harder blow to these funds, as many of these sectors have dropped sharply. Near-term returns, thus, do not hold answers to their potential. Given a market rally, especially if election results are market-favourable, these funds can see returns bounce back.

• For funds that are showing high 1-year returns, more often than not, it is because they picked up the handful of stocks that rallied despite the correction (and held them in high concentration). These returns need to be seen in the context of longer-term performance and consistency. Where they are not favourable, we would still refrain from including them in the Select list.

Patience is key in equity. As long as you have a properly asset-allocated and category-allocated portfolio and hold quality funds, do not worry over the dip in returns from last year. Markets always go through cycles.

Tight liquidity and heightened repayment concerns post September sent debt yields soaring, especially on short-term instruments. The dearth of confidence in debt markets has since eased a bit.

The past quarter saw a complete reversal on the rate hike expectations that prevailed for much of 2018. 10-year government bond yields dropped to 7.27% by December 2018 from the 8.18 in September 2018. 10-year yields are now at levels seen this time last year. Inflation remaining low despite high fuel costs, crude oil prices significantly off their highs, and the Reserve Bank’s monetary policy commentary put rate hike expectations behind. In this scenario,

• There may be duration opportunities on rate cut expectations, based on inflation data, global events and RBI action. But given the manner in which rate outlooks have changed in the past two years, the quick market reaction, the recent gilt rally, and the overhang of global events, we’re being cautious with adding funds that take duration calls.

• Where we do have a dynamic bond fund in the list, at this time, it remains firmly in an accrual strategy. It has not used the past few months to take gilt calls unlike other dynamic bond funds.

• Accrual funds can still snag gains from rate-cut led bond price rallies with their AAA holdings without needing to take interest rate calls. Short-term and medium-term funds hold papers with high coupons and this can keep returns up even without the added duration gains.

• We also believe that short-to-medium term accrual funds could offer better opportunities if we move to a rate cut phase or even a rate pause phase. However, we have been circumspect in adding funds with high yields or returns coming from higher holdings in money market instruments. CD and CP yields can come off the high levels given the rate scenario at this time. We prefer accrual through short to medium high-quality corporate bonds.

We had talked about the seemingly poor performance in hybrid funds in our previous review. To reiterate, this set of funds has been hit on two fronts – a combination that rarely happens. One, equity markets were sinking. Several aggressive hybrid funds try to push up their equity returns by moving to smaller stocks. The steep dip in midcap and smallcap prices hurt. Second, volatility in bond yields hurt debt returns.

Keep in mind two points – one, an equity slide, even if equity accounts for 25% of the portfolio can hurt returns in the short term. Two, hybrid funds will still earn the coupon on their papers, which can reverse the effect of bond price volatility on near-term returns.

As a FundsIndia investor, you would have received an email detailing the changes to the Select Funds list and the rationale for the same. You can log in and view the latest Select Funds list here.

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