Equity Fund analysis- 2006-07

A bumpy ride
Sandeep Singh Posted online: Monday , July 02, 2007 at 1541 IST
Updated: Wednesday, June 29, 2005 at 1257 hours IST -->

A review of equity fund performance over two different time periods — the past three years and the past year — is a study in contrast. While it does highlight the nature of equity investing, and the elements of speed and danger, it also shows how numbers can be misleading.


Behind the numbersOver a three-year period, equity funds have earned their spurs. As many as 39 of the 51 diversified equity schemes and 10 of the 14 equity-linked savings schemes (ELSS) have bettered the benchmark BSE Sensex, and rather impressively too. But shrink the period of study to one year, and the performance turns on its head. The number of Sensex beaters drops to just four in the diversified equity set and zero in the ELSS set.
The variance in numbers is the result of the cut-off date: May 31. It was around this date last year that the market started crumbling, with the Sensex falling about 14 per cent by June 14. If we move the cut-off to June 26, as many as 92 of the 178 diversified equity schemes with a one-year record have bettered the
Sensex. This shows that when the market fell, many funds were in cash and they went on a value hunt, which has paid off.
Of course, an equal number haven’t. Says Rajiv Anand, head of investments, Standard Chartered Mutual Fund: “The rise in the Sensex was restricted to select stocks, and the small- and mid-caps trailed the large-caps.” Only nine of the 30 Sensex stocks bettered the Sensex return in the June-to-June cycle, seven even depreciated. Selectivity, even discretion, has characterised market movement since, and this is likely to continue. That’s why you need to choose your scheme well.
The performersLeading all diversified equity funds is Sundaram BNP Select Midcap. On three-year returns, it is among the best, but on one-year returns, it’s the second worst. Says N. Prasad, chief investment officer, Sundaram BNP Paribas AMC: “Mid-caps suffer when interest rates rise. We had a high holding of cash in anticipation of that happening. Now that rates are close to peaking, we expect value to be unlocked in the next six months.”
A noteworthy mention is SBI Mutual Fund. Over our period of study, its performance is, unarguably, the best. Three of its four diversified equity funds are in the top 15, the maximum among all fund houses: SBI Magnum Contra (number 2), SBI Magnum Global (number 4) and SBI Magnum Multiplier Plus 93 (number 12). Not only that, it occupies the top slot in ELSS and balanced funds.
The 16 diversified equity funds and the four ELSS that have bagged either four-star or five-star ratings make for worthy investments. But tone down your returns expectations. The short run is likely to see immense volatility. If you are investing for the long term, such swings shouldn’t make a difference. If that’s your horizon, keep making regular investments. Says Vikrant Gugnani, chief executive officer, Reliance Mutual Fund: “GDP growth of above 9 per cent is here to stay. A rise of 15-25 per cent a year in corporate earnings over the next three years is realistic.” Adds Anand: “Stocks in the small- and mid-cap segment still offer good value.” Many funds will tap that value and realise it. Given their track record, many of the ‘starry’ ones should be among them.
How we did itTrack record, consistent performance and risk management are the hallmarks of a good scheme. Using several quantitative tools, the Express Money-ICRA Online mutual fund rankings captures how the universe of schemes has fared towards this end.
We classified all the schemes into 10 categories: three in equity, six in debt and balanced. In order to enable comparison, we took the growth plan only. Further, to keep it relevant for you, we took only the retail plan of open-ended schemes. Next, we demanded a track record (NAV of three years), transparency (monthly portfolio disclosures) and size. (we knocked off the bottom 10 per cent of schemes, provided their corpus was less than 10 per cent of the largest in that category).
The rankingThe set finalised, we ranked all schemes on the basis of a composite score. Ranking schemes only on the basis of returns is simplistic. A fund could be generating higher returns, but it might also be taking on more risk. Risk-adjusted returns present a more balanced picture and the three statistical measures that capture it are:
Sharpe Ratio. The Sharpe Ratio is calculated by subtracting the risk-free rate of return from the returns generated by the fund, divided by its standard deviation. In simple English, the Sharpe Ratio measures reward per unit of risk. The higher this number, the better.
Downside probability. This counts the number of days the fund generated negative returns and divides it by the total number of investment days. It captures the adverse movement in a fund’s return profile. The lower this number, the better.
Liquidity coefficient. This tells how efficiently can an equity fund sell all its holdings. The liquidity coefficient for a fund is the weighted average of the liquidity coefficients of all the scrips in its portfolio. The liquidity coefficient of each scrip is the number of shares in the scheme portfolio divided by the daily turnover of the scrip.
In equity and balanced funds, we gave a weightage of 45 per cent each to Sharpe and downside, and 10 per cent to liquidity. In debt funds, liquidity is less of an issue, and so was ignored. Scores across categories aren’t comparable. They are within each category and indicate the gradation in it.
Scores and ranks can indicate a greater level of gradation than there is. So, we created representative clusters, by assigning star ratings. The top 10 per cent of the schemes in the category were given five stars, the next 22.5 per cent four stars, the next 35 per cent three stars, the next 22.5 per cent two stars and the final 10 per cent one star.