We are living in strange times. No, I am not talking of Covid-19. Your one-year returns of equity funds (across categories), at an average 31% between January to March 22, 2021, zoomed to an average 69% since March 23, 2021. In other words, 1-year returns suddenly doubled from March 23, 2021. If you recall, March 23 2020 was a market low. So, 1-year returns from March 23, 2021, have started looking abnormally high.
This has caused an aberration in the return charts of mutual funds. Funds that languished in the third and fourth quartile of performance charts are competing at the top now. Though this ‘high return effect’ is tapering off slowly, it can still send you wrong signals. You will have funds that tempt you to invest, with their sky-rocketing 1-year returns pushing even their 3-year returns.
More importantly, this phenomenon is also showing some of the otherwise steady performers in bad light, possibly pushing you to exit them. Decisions made at this juncture can therefore go wrong.
This does not mean you should not participate in the kind of rally that we are witnessing. The current rally is driving some of the bottom-rung stocks up. That means there are individual stocks that are moving up steeply, not necessarily buttressed by any sector trend. In such cases, it is best that you pick individual stocks to play such momentum. In other words, stick to MFs for the long term and use such stocks as you may ‘discover’ for any tactical plays, if you really wish to.
In debt, the period of low return continues to linger, frustrating many into high-risk products such as covered bonds or risky NCDs that we wrote about recently. We are trying to balance your need to have higher returns without excessive risks. More about it later. We just set the context for what to expect from us in this quarter’s review of our funds 😊 Needless to say, we are not going by the current fancied funds because they still fare poorly when we run our internal research methodology.
About Prime Funds
Prime Funds is our list of best mutual funds across equity, debt, and hybrid categories. We use Prime Ratings, our fund ratings, as a first filter and then use qualitative analysis to design our fund recommendations. Prime Funds is an enduring list of funds that you can use, and you will find a fund that meets any goal you’re looking to meet.
If you are new to PrimeInvestor, you need to know the following about Prime Funds:
Different categories: Prime Funds are separated into buckets, based on risk level in equity & hybrid funds, and timeframe in debt funds. Each of these draws from different SEBI-defined categories. We do not go only by Prime Ratings but look at other factors as well. Our reasoning for this is explained here.
Different styles: In Prime Funds, we’ve aimed at providing funds that follow different strategies for you to mix styles and diversify your portfolio with ease. The ‘Why this fund’ for each Prime Fund will brief its strategy, why we picked it, and how to use it in your portfolio.
Direct plans: We have specifically given the direct plans in Prime Funds. We have observed that even in top-quality funds, the regular plan’s expense ratio can be significantly higher than the direct plan. In such cases, the direct would be the better option to go for. Check our MF Review Tool (and not just our ratings page) to know if you can go for the regular plan as well. Our reasoning is explained here.
Review: Our aim in reviewing the Prime Funds list every quarter is to ensure that we don’t miss any good opportunities that are coming up and we are not holding on to funds that are slipping. When we remove funds from the Prime Funds list, we tell you exactly what to do if you have invested in these funds. Funds we remove do not immediately call for a sell – it is just that they have slipped in performance marginally or there are better alternatives now. Unless our review tool says such funds are a ‘sell’, you can hold them (refer to our article on when to sell funds.)
Using Prime Funds: You do not need to hold every Prime Fund nor add any new fund we introduce to the list. Unless it fits your overall portfolio/strategy, or there is something lacking, there is little need for you to go on adding funds. Our idea of covering them in detail through some of our weekly calls is to let you know the strategy, style, and suitability in different portfolios. It is not a specific call to buy right away, unless we mention it is.
As mentioned earlier, the current wild market upswing has not pushed us into making significant changes to our equity fund list. Yes, there has been underperformance in some of our recommended funds. But we prefer to watch, given the market conditions, and not act in haste. The reasons for the underperformance can broadly be classified as follows:
- A strategy/style is underperforming in the current market and impacting schemes across an AMC.
- The funds did not fall steeply in the market hit of March 2020 and therefore do not have a low base to show high returns now.
- Many of the mid and small-cap stocks that have zoomed in recent months are part of the mid or small cap index, but are little held by mid and small-cap funds. This has therefore caused significant underperformance in the funds.
Let us look at some of the Prime Funds that we are watching for underperformance and their reason for lagging their benchmarks.
Equity funds – divergence from index
Equity – Moderate: Kotak Flexicap’s performance has lagged the Nifty 500 TRI from about August last year. The fund has marginally underperformed the index before. This time, though, the gap between the fund and the index has been higher. This lag can be explained by the nature of the market movement in this rally as well as stock choices that the fund made. Top stocks in the fund’s portfolio, though quality names, have not been among those that soared high.
So, while Kotak Flexicap did benefit from the high returns clocked by the likes of State Bank of India, Infosys, or ICICI Bank, it was also weighed down by sedate returns of HDFC Bank, Hindustan Unilever, Petronet LNG, L&T, and TCS. The fund has begun to narrow the gap by which it trails the Nifty 500 TRI. We’re watching the fund for continued improvement in performance before taking a call on the same.
Funds from Axis AMC, such as Axis Bluechip (and other funds not in our list) have seen slower performance as their growth-focused strategy has underperformed. A similar story panned out in Mirae Asset Large Cap as well. At this juncture, we are not too worried about these downswings.
Equity – Aggressive: In the mid and small cap space, there is a significant divergence between funds and their indices, with the former undershooting indices by a mile. Such underperformance is in the range of 10-25 percentage points (on the 1-year return) since March end. Funds such as DSP Midcap, Axis Small Cap and even the top returning SBI Small cap have underperformed. This kind of divergence (underperformance) from the index is best ignored at this stage as the nature of stocks that have rallied in the mid and small cap space are not the ones that would enter the filters of mid and small-cap funds, either due to liquidity, quality, or governance issues.
Equity funds – additions
We have made minimal additions to our recommended funds list, for the reasons mentioned above. The funds we’ve introduced are as follows.
Equity – Passive funds
We have not added new funds in the moderate or aggressive space. We have instead added one index fund – HDFC Index Fund – Sensex Plan to our ‘Equity – Passive funds’ list. This is more an effort to complete the passive large-cap space. Some of you have asked us why Sensex funds are not available and whether Nifty outperforms Sensex or vice versa. We’ve included the index now.
As far as the second question goes, the truth is this – past data shows that it does not matter one way or the other if your holding is five years or more. The Nifty has beaten the Sensex by an average 0.15 percentage points if you take 5-year rolling returns for the past 15 years. However, if you take the last 8 years, the same 5-year returns of Nifty underperformed the Sensex by 0.3%.
Hence, to keep it simple, we had stuck to one index, the Nifty 50. However, for those who like the compact portfolio (30 instead of 50) and therefore higher weight to individual stocks in the Sensex, we are providing an option that has low tracking error and reasonable expense ratio. We are neutral to whichever index you opt for. You can go for either.
We note that our addition of a commodities fund worked well. Now, we are adding one more cyclical sector – infrastructure – through Invesco India Infrastructure. Currently, IDFC Infrastructure is an outperformer in this space. However, we have chosen Invesco India Infrastructure for two reasons.
One, while the IDFC fund has outperformed due to its overweight position in construction and allied activities, we prefer the diversified exposure in Invesco as its portfolio is more spread out over construction as well as engineering and capital goods. It does not hold banking & finance. We prefer this diversification at this stage to capitalize on capex stories outside infra and prefer an infra fund without banking, given that it is available in all other fund categories.
Two, the Invesco fund has been a highly consistent performer beating the infrastructure category average 85% of the times when 1-year returns were rolled daily for the past 3 years. This is significantly higher than the just 14% outperformance proportion of peers by IDFC Infrastructure. If you decide to go with the Invesco fund, keep exposure limited to under 5%. You can invest in lumpsum and use market dips to accumulate. Otherwise use short SIPs of 6-9 months.
In the debt funds space, neither have funds managed great accrual returns nor has any duration played out constructively. Even as the rising inflation has put pressure on yields, RBI operations to keep rates under check have resulted in a lesser-than-expected pace in yield rise. To this extent, your ultra-short or short or corporate bond funds have not seen a sharp climb in their yield to maturity (YTM) resulting in returns languishing.
Debt funds - additions
We have introduced a couple of funds to improve your return prospects. We have not removed any fund.
Debt – Medium term 3-5 years
We introduce ICICI Pru Corporate Bond fund – a consistent fund at par in performance with ABSL Corporate Bond and Kotak Corporate Bond. This fund too can go between 1-4 years in average maturity and will hold top quality bonds as required by SEBI for this category. While we already have 3 funds in this space, we introduced this one primarily because its average maturity is marginally higher than the other 2 mentioned above and closer to HDFC Corporate Bond fund but with less volatility.
With this addition, we would have corporate bond funds across the maturity curve. If you were to hold more than 1 corporate bond fund, you could use a combination of ABSL Corporate Bond or Kotak Corporate Bond (for lower duration) along with HDFC Corporate Bond or ICICI Pru Corporate Bond.
Debt – Long term – above 5 years
For the first time since our platform launch, when the credit environment was not conducive, we are now cautiously approaching the credit space for those who seek additional returns. Here again, our aim is to keep risk at bay, even if this is a credit risk space.
Here, the contenders were ICICI Pru Credit Risk and HDFC Credit Risk. Between these two, we preferred ICICI Pru Credit Risk for 2 reasons: one, its YTM is higher without significantly higher credit exposure, providing better prospects. Two, its worst returns (over 1-year periods for the last 4 years) were 5.86% as opposed to 3.9% for the HDFC Fund suggesting better downside risk management. ICICI Credit’s risk-adjusted return is also superior, hinting at lower volatility.
Please note that this is not a fund for those who are looking for FD substitutes or for low-risk debt investments. This is a high-risk fund and any of the credit issues of 2018-20 can play out in this fund as well. Hence, having a very long-term horizon and ability to take hits is an absolute must. Use it only to buttress returns from the debt component of your portfolio, to tide over low-return times such as the case currently. Exposure should be curtailed to under 10% of your portfolio. Else, please stick to our corporate bond recommendations. (Kindly don’t read too much into the choice of 2 funds from the same fund house. It is merely coincidental 😊)