• Investment World
• eWorld
• Catalyst
• Mentor
• Life
• Canvas
• Praxis
• Urban Pulse
• Brand Quest

Suresh Krishnamurthy

WHEN it comes to delivering superior risk-adjusted returns, inconsistency has been the hallmark of diversified equity mutual funds. Funds that do well in a bull market fail to perform in a down situation.

An appraisal of the risk-adjusted performance of equity mutual funds between January 1999 and March 2003 bears this out. However, while this is true of equity mutual funds as a whole, a handful of them have done well across various periods. This should provide some relief to investors who are banking on actively managed equity funds.

A Business Line study examined 31 mutual funds that have been in operation since January 1999. The monthly returns of these mutual funds and the monthly returns of S&P CNX Nifty Total Return Index were considered. The analysis revealed that:

Equity funds are generally riskier than S&P CNX Total Return Index. However, there has been a marginal decline in the risk levels since April 2000.

Funds deliver superior risk-adjusted performance during up-markets and inferior performance in a down market.

Portfolios were relatively more diversified from April 2000 to March 2003 than they were in the January 1999-March 2000 period.

The contribution of non-skill-based factors to surplus returns during rising markets is highly significant. This may mean that sector-specific rallies (such as those in the tech, PSU and banking sectors), rather than stock selection, are behind superior performance. The fund manager's skills have been certainly important, but only moderately so.

An exceptional show over one period could potentially distort returns when measured for an extended time. For example, performance in 1999 is still skewing the returns of a few funds, such as those of Alliance and Birla, in their favour. While this may be alright for someone who has stayed invested in the funds since then, it does not provide a reliable benchmark for one who may enter the fund randomly and who, in addition, may also exit from it after holding it for a relatively short span.

Superior returns

An analysis of risk-adjusted returns from January 1999 to March 2003 reveals that 22 of the 31 funds delivered significantly superior risk-adjusted returns. However, since April 2000, only 15 funds turned in a superior risk-adjusted performance.

Between January 1999 and March 2000, there was an unprecedented bull run in the equity market. In contrast, the April 2000-September 2001 period saw large losses. The market has since recovered only some of these losses.

Overall, only 10 funds delivered superior performance across various periods. These are Zurich India TaxSaver, Zurich India Equity, Zurich India Top 200, Franklin India Bluechip, Franklin India Primaplus, Franklin India Prima, Reliance Vision, Reliance Growth, Templeton India Growth and UTI Index Equity Fund.

It may be difficult to believe that some funds delivered inferior returns from January 1999 to March 2000. Indeed, some funds from the UTI stable, such as UTI Grandmaster and UTI Masterplus Unit Scheme 91, did just that. Their performance since April 2000 has improved and they have turned in higher risk-adjusted returns. GIC Fortune 94 has a similar record.

Interestingly, the overall risk level of equity mutual funds has come down marginally. However, it is still higher than that of the market. This suggests that, typically, funds will continue to underperform during down markets and outperform during periods of rising prices. Therefore, any appraisal should consider both periods before evaluating equity mutual funds.

In addition, the influence of the monthly returns of S&P CNX Nifty Total Returns Index on those of equity mutual funds has increased. This can be interpreted to mean that the portfolios now are more diversified than they were in the hey-day of 1999 and 2000.

The increase in the influence of Nifty's monthly returns has implications for future performance. If the influence keeps increasing, it would suggest that equity funds are diffident about picking stocks that do not move along with the market. That might restrict the extent of their outperformance.

Chance factors

Between January 1999 and March 2003, Zurich India TaxSaver delivered annualised returns of 30.6 per cent. During the same period, S&P CNX Nifty Total Return Index delivered returns of 4.4 per cent. Of the excess returns, fund manager skills accounted for just 2.3 percentage points.

There is the suggestion that chance factors can take the credit for much of the surplus returns. This is true for all funds that delivered superior returns. In addition, the contribution of non-skill factors to excess returns is discernible in the performance of equity funds in other periods of rising prices as well. What are these chance factors?

A sector-wide rally could be one explanation. Since 1999, there have been many sector-specific rallies. One sector or the other has been the flavour of a particular six-month period.

A fund manager needed to be diligent to make sure he had exposures to that particular sector at that time. That would automatically deliver superior returns.

Or, it could suggest that S&P CNX Nifty Total Return Index is not the appropriate benchmark for comparison. A different benchmark, such as S&P CNX 500, could provide a different picture. However, such a suggestion is not appropriate.

This is because the monthly returns of the Nifty explain, on an average, 70 per cent of the returns from equity mutual funds. Such a high degree of correlation suggests that Nifty is, indeed, the appropriate index. Overall, the contribution of chance factors implies that diversified equity mutual funds have made the most of sector-specific rallies. This begs the question whether, in the absence of such rallies, these funds deliver superior performance.

Picking index-beaters

Ideally, investors should pick funds whose risks are lower than that of the index but still deliver superior performance. However, there are only a couple of funds significantly less risky than the index.

They are Templeton India Growth and Reliance Growth. In Reliance Growth, the lower risk relative to that of Nifty is misleading. This is mainly because the fund invests substantially in mid-cap stocks.

In this backdrop, only Templeton India Growth emerges as a viable, low-risk alternative. There are, however, a number of funds whose risk is similar to that of the index — Zurich India TaxSaver, Zurich India Equity, Sundaram Growth and Zurich India Top 200.

The risk involved in funds such as Franklin India Bluechip, Franklin India Primaplus and Franklin India Prima is higher than that of the index.

Of the funds with long-term records, these are the only options that emerge as investment-worthy. Other funds have inconsistent records and will need appraisal over a longer period.

A number of funds have been launched since 2000. A few of them may emerge as index-beaters and more worthy investment propositions a few years down the line. That remains to be seen.

At a broader level, however, it is clear that most equity funds will find it difficult to register index-beating performances. In addition, if sector-wide rallies become outdated, the extent of out-performance of equity mutual funds in rising markets may be smaller than in the past.

While a few funds may continue to deliver superior performance, equity mutual funds as a class may not be index-beaters. Overall, the onus is now that much more on the investor to check out a fund's antecedents before parking his money in it.

Article E-Mail :: Comment :: Syndication

Stories in this Section
OCL: Accet

Copyright © 2003, The Hindu Business Line. Republication or redissemination of the contents of this screen are expressly prohibited without the written consent of The Hindu Business Line