Ranking income funds: Misleading

Suresh Krishnamurthy

``THERE has recently been a lot of noise in ranking income funds,'' says Alok Vajpeyi, Chief Executive Officer, DSP Merrill Lynch Investment Management, in his monthly communication to investors. The substance of his communication is that performance alone should not be used to rank funds. One cannot but agree with him.

The exercise of ranking income funds is irksome for managers of large funds as most large funds fall in the last quartile in terms of performance. The contention of managers of large-income funds needs to be viewed in this backdrop. Their argument is that large funds offer the benefit of diversification and thereby reduce market risk. This is, indeed, quite true.

Smaller funds necessarily are focussed funds, though mid-sized funds are not. Mid-sized funds are fairly diversified and also offer better returns than the large funds. Even if mid-sized funds are judged as riskier than large funds, the returns quite adequately compensate for the higher risk involved. In short, the penalty for remaining invested in large-income funds appears disproportionately high.

In India, there is a problem with large-income funds. At a time when economic activity in India is quite subdued, managers of large-income funds have had problem in deploying their funds at attractive rates. It is also not fair to uniformly dub large-income funds as less risky. In fact, given their reduced ability to change the average portfolio maturity in tune with the fundamental changes, they are, at times of highly volatile movement in interest rates, riskier than small funds.

Also, large funds have not offered investors a better deal in terms of lower percentage costs. In fact, by effecting a substantial reduction in costs, large-income funds can be as competitive as mid-sized funds in performance. But for now, it does make sense for investors to seek out well-managed mid-sized income funds.