A yawning gap in fund returns :: Business Line

Please Share:: India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��

Planning to buy an equity fund? Then pay close attention to how you select it.

In India, the choice of funds can make all the difference to wealth creation. Across mutual fund categories, but particularly in equity funds, there is a yawning chasm between returns delivered by the best performing fund and the worst performing one.

In the past five years, for instance, the top five funds each year outperformed the bottom five by anywhere between 22 and 90 percentage points. That is, if the top funds delivered a 100 per cent gain, the worst ones managed between 10 and 78 per cent!

The differences were highest during bull markets. In the market rebound of 2009, the top diversified equity fund — Principal Emerging Bluechip — delivered a 147 per cent gain to its investors. The worst performers managed less than 50 per cent, a third of that!

But return divergence is quite high in more sober market conditions, too. Take 2011, when the Sensex lost 24 per cent in value. The same year, the top five funds contained their losses to 7 per cent while the five biggest laggards saw their net asset values fall 45 per cent.

WHY?

There are a couple of explanations for why fund returns diverge so much in India. One reason could be that fund managers in the country are no index-huggers. In fact, most active equity funds invest aggressively outside of the Sensex and Nifty baskets in their hunt for that extra return.

What also makes such a strategy necessary is that the Indian bellwether indices — Sensex and Nifty — are narrowly defined and comprised of just 30 and 50 stocks respectively. For an active fund looking for the best opportunities, there is plenty of action in the other 6,000-odd stocks that make up the listed universe. Apart from this, return differences seem to arise from the fund manager's preferences for specific styles or market cap.

WHAT YOU SHOULD DO

So, given that divergence in fund returns can be so high in India, what should investors do? That they must select funds with a good long-term track record goes without saying. But besides this, they may follow the following safeguards to make sure they don't get stuck with the lemons.

If in doubt, stick with diversified equity funds. A run-down of the return rankings over the past five years clearly shows that both the best and worst performing equity funds each year tend to be thematic funds.

The difficulty, however, is in figuring out when a theme will take off and when it will crash-land. For instance, funds focussed on MNC stocks have done exceedingly well in 2012, with returns of 14 to 18 per cent. Those betting on infrastructure were predictably the worst performers with most suffering declines. In 2009, roles were reversed. MNC funds were laggards while infrastructure funds delivered the goods. This suggests that if you want to avoid large gaps between the performance of the fund you hold and that of the market as a whole, it is best to stay with diversified equity funds.

Watch your portfolio like a hawk. It is not enough to select four or five funds, buy them and then simply wait it out over five or 10 years to rake in equity returns. If a fund you own undergoes an ownership or management change, or simply begins to drift, the price you pay in terms of lost opportunities can be quite high. Therefore, review your portfolio at least twice a year. Replace funds that have slipped against their benchmark or category average for three years at a stretch.

Past performance is no guarantee of future returns. Therefore, you simply do not know if a market-beating fund that you picked for your portfolio will continue to do a stellar job over the next five years. That is why apart from holding actively managed funds, you may need to ‘insure' your portfolio with a 10-20 per cent exposure to an index exchange-traded fund. That will ensure that your portfolio keeps up with the market and shields you from the risk of a fund manager failing to deliver sufficient returns for the risk he is taking on.