Mutual funds -- The hold-sell-or-buy dilemma

Suresh Krishnamurthy

MUTUAL funds no longer prefer to sit on a mound of unrealised capital gains.

Going by their operations in 1999-2000, they now prefer to adopt an active management strategy of booking profits to take advantage of a rise in prices. Compared to 1998-99, when of the total income of equity schemes, realised gains (that is profits booked, in contrast to unrealised gains) accounted were 30 per cent, in 1999-2000, profits booked accounted for a little more than 70 per cent.

This aspect of mutual funds operations is revealed by the abridged revenue accounts for 1999-2000, of 19 equity schemes. While the extraordinary performance of equity schemes in 1999-2000 is well-chronicled, the revenue accounts throw light on the investing strategies that paid funds rich dividends in 1999-2000.

Performance: No linkage

While mutual funds have had several opportunities to book profits in 1999-2000 due to the market-wide rally in stock prices, there appeared to be no linkage between profit-booking and performance. A higher proportion of profits booked did not, however, automatically lead to better fund performance in terms of returns. In other words, funds that booked profits did not necessarily outperform funds that held on to unrealised gains.

For example, Kothari Pioneer Infotech Fund and Alliance Capital Tax Relief, the top performers among the equity schemes considered, derived more than 50 per cent of the total income from profits booked. In contrast, Alliance Equity Scheme and Birla Equity Plan which derived less than 20 per cent of the income from profits booked, performed equally creditably. Also, schemes such as Kothari Pioneer Prima Plus, Kothari Pioneer Bluechip, Zurich India Top 200 and Sundaram Growth Fund, which also plumped for a larger share of profit-booking registered much lower NAV appreciation.

In short, with the proper stock selection, a buy-hold strategy would have delivered as much returns as one of active portfolio management. However, the latter, due to higher transaction costs, may have even pulled down the performance.

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No link to asset accretion

There appeared to be no linkage between increase in profits booked and growth in net assets. Only in Zurich India Capital Builder, which had to counter large-scale redemptions as the fund went open-ended in January 2000, was any link between profits booked and growth in net assets perceivable. Zurich India Tax-Saver and Kothari Pioneer Bluechip, whose corpuses increased significantly in 1999-2000, plumped for large-scale profit-booking, while Alliance Equity Scheme, whose net assets also increased sharply, opted to hold on to gains.

The trend varies, even among equity schemes of the same fund. For example, in Alliance Mutual Fund, Alliance Equity Fund held on to gains while Alliance Capital Tax Relief booked profits. But the tilt is generally in favour of booking profits. Generalisations on a particular mutual fund, therefore, cannot easily be made, and the investing style may vary with each equity scheme.

Shorter investment horizons?

Every mutual fund offer document and prospectus highlights the virtues of long-term investing. And every fund manager commends its advantages to retail investors. But have the managers taken a different tack and opted for shorter investment horizons?

While a higher percentage of profit-booking in the total income might suggest just that, a look at the losses suggests otherwise. In funds such as Kothari Pioneer, Zurich India and Sundaram Growth, which have disclosed details of provisions for losses, it is apparent that they have not booked as much losses as profits.

For example, Kothari Pioneer Bluechip booked profits to the extent of Rs. 29.91 crores, and profits that remained unrealised at end March were of the order of Rs. 16.82 crores. In contrast, the fund had booked losses to the extent of Rs. 3.45 crores, while losses unrealised stood at Rs. 15.17 crores at end March. In short, the fund could have cut losses further, but opted to stay with its holdings.

This reluctance to book losses is evident, even in other equity schemes that have disclosed provision for losses. Given the trend of similar practices on all other parameters, it appears fair to conclude that other mutual funds also tend to hold on to stocks that are in negative territory in terms of returns.

Earlier, in 1997 and 1998, many of the funds undertook extensive restructuring, and even took losses to bring their portfolios back to shape. Now, however, funds appear to be reluctant to book losses. This suggests that mutual funds do practise long-term investing (at least in exposures where there is loss looming at current prices). This is contrary to the impression gained when the profits booked are looked at in isolation.

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Funds as traders

However, it appears reasonably certain that a high degree of portfolio churning is taking place. The sum of profits and losses (an indirect indicator of the value of transactions), as a percentage of net assets, is more than 50 in nine cases, while it is less than 20 in only three cases. Juxtaposed with the growth in inflow of funds, especially during the close of the year, which sharply increases the base of average net assets, the figures do appear high, indicating a greater degree of portfolio turnover.

These figures, along with stock market trends, indicate that the funds are typically entering and exiting a particular stock at various levels, depending on market movements. Funds may consider a stock positively from a long-term perspective, but would still book profits partially if market signals indicate near-term weakness.

Momentum-investing, especially in funds benchmarked against the Sensex and Nifty, appear to be the order of the day. This phenomenon may have been triggered by the large up and down moves in stock prices in 1999-2000. It remains to be seen if this trend will continue if stock prices increase at more modest levels or show flat trends.