Quarterly review: Changes to recommendations in Prime Funds & Prime ETFs

Prime Funds is our list of recommendations in equity, debt, and hybrid mutual funds that are worth investing in. Prime Funds narrows down your choices from the thousands of funds that there are, into a concise list of funds that span different styles. Prime Funds are selected based on performance, portfolios, and investment strategies. 

In this quarter’s review, we have added to equity funds to play themes that are ripe and made changes to the hybrid recommendations to include better return options. We have made minimal changes to our debt fund recommendations. 

If you are new to Prime Funds, do read the section on ‘About Prime Funds’ to know how to use them to your advantage. Otherwise, use the Table of Contents below to navigate to the section of your interest.

Equity funds

The Nifty 50 and Sensex made merry in the December 2022 quarter, notching up new peaks. But the mid-cap and small-cap segments still had some struggle and small-caps are yet to reach their own earlier peaks. As we explained in our Prime Funds 2022 performance review recently, funds that held true to a buy-and-hold strategy found it harder to hold up in the sideways markets we have seen for much of this year. This apart, funds that followed a more growth-oriented strategy also saw poorer performance as value came to the fore.

Our changes in equity Prime Funds over the past few quarters have been aimed at curbing underperformance where it was stark and identifying up-and-coming funds early. To this extent, our equity fund recommendations have held up well. The changes we’re making to the recommendations are minimal. We have, however, explained the underperformance in some of the funds and which we are watching for improvement. 

Equity – Moderate (Active and Passive)

In this set of Prime Funds, we have removed ICICI Prudential Nifty 100 Low Volatility 30 ETF FoF that comes under the Passive category. We chose this as the index had showcased the ability to both deliver long-term returns and protect downsides. The Nifty 100 Low Vol 30 has served the purpose of containing downsides; its monthly downside capture ratio holds up well. However, the index has been returning far lower than the Nifty 100 (a limitation in factor-based indices is that historical levels that are calculated and provided prior to the index’s actual launch are often theoretical to fit the factors chosen. Real-time performance can differ). 

On a rolling 1-year basis, the return differential between the Nifty 100 and the Nifty Low Vol 30 has gone up to even 10 percentage points at times in past 2 years. The stark differential has also impacted the longer-term returns as well, with the two indices very similar in returns. In the absence of healthy returns, there is limited purpose that the Low Vol index may serve. 

Continue to hold investments made so far in the ICICI Pru Nifty 100 Low Vol 30 FoF, if you have any. It can retain its purpose of protecting downsides. However, avoid making further investments in the fund and increasing exposure. For any SIPs, you can divert the amount to an index fund tracking the Nifty 50 or the Nifty 100, or even in active funds that score on downside containment and low volatility.

There are no other changes we are making in the Equity – Moderate Prime Funds set. However, we’d like to explain the performance of two funds as below. Please note that the funds remain part of the recommendation. We will alert you if any action is required.

• Canara Robeco Flexicap fund has been trailing the Nifty 500 TRI for the past couple of quarters. The margin of underperformance is not very deep ranging at about 2-4 percentage points. The fund’s growth-oriented investment style has pinched returns as value came to the fore. That saw the fund be underweight on some sectors and stocks that outperformed. For example, while the fund had a heavy banking weight, it held more in stocks such as HDFC Bank that were underperformers. It did not hold as much in capital goods, auto, cement, or realty all of which were outperforming sectors. Its IT and chemicals picks hurt, while its consumer picks are only just looking up. We are not too worried about the fund’s performance at this time. We are watching performance and will take a call if necessary.
• Parag Parikh Flexi Cap buckled under the pressure faced by its US stock exposure. That exposure has come down to 15% of the portfolio now from 29% in January 2022 on account of stock price correction; the fund has used the correction to average in these stocks. The domestic portfolio is holding up well and its value tilt can continue to see it perform. We have explained the fund in more detail earlier. The fund remains part of our list.

Equity – Aggressive (Active and Passive)

In this Prime Funds category, we have removed UTI Flexicap from the list. We had noted its underperformance in the previous review but had retained it stemmed from some contrarian calls. However, the depth of underperformance has worsened over the past quarter and the fund now trails the Nifty 500 TRI by about 14-15 percentage points on a rolling 1-year return basis. Apart from a higher holding in IT stocks that weighed, the fund was also underweight on outperforming sectors such as auto and financials. The fund does have exposure to sectors and stocks with potential such as cement, niche IT, capital goods and consumption. However, without signs of performance improvement, it is best to stop further investments in the fund. Stop SIPs if running and retain all investments made so far.

We have also removed Union Small Cap from the list. This is not due to performance. The fund’s manager Vinay Paharia, who was instrumental in its turnaround, has resigned. The investment processes he put in place continue to hold and the current fund manager was co-managing the fund earlier. However, we wish to be cautious on the fund given the category, the fund’s smaller size, and the role Mr Paharia played in its performance improvement. Stop SIPs if running and retain all investments made so far.

In the Passive section of this Prime Funds category, we are adding Motilal Oswal S&P 500 index fund. This index fund tracks the S&P 500 index, a US market index that represents the 500 largest and most liquid US stocks. The index is a major US market index and is more diversified and less tech-heavy than the Nasdaq 100 index. This index fund was earlier part of Prime Funds, which we removed last January due to RBI’s restrictions on funds investing internationally and funds closing off fresh subscriptions in consequence. As this fund is now accepting fresh inflows, we are adding it back. It can be used by those looking to diversify their portfolio overseas. 

There are no other changes we are making in the Equity – Aggressive Prime Funds set. However, we’d like to explain the performance of two funds as below. Please note that the funds remain part of the recommendation. We will alert you if any action is required.

• PGIM Flexicap is currently trailing the Nifty 500 TRI. This is a fund we added for its ability to churn portfolios to play different themes. The fund is a tad more aggressive with a higher mid-cap and small-cap allocation, which has hurt recent returns. This apart, some focused exposures such as Infosys, HDFC Bank, CAMS, as well as smaller holdings in other stocks hurt. However, the fund’s strategy of quick churn and identifying performers continues to hold good and it has made several timely entry, book profit, and exit calls. Its long-term returns are also well above peers and index.
• SBI Focused Equity has fallen behind the Nifty TRI in 1-year returns which has marginally spilled over into 3-year returns. For focused funds, a bigger underperformance is not surprising owing to the concentrated stock holdings which amplifies the impact of calls going wrong. In this fund, the top bets of Reliance Industries, HDFC and Infosys have all served to stymie returns. It also follows a buy-and-hold strategy which has taken a backseat in this shifting market. the fund’s portfolio is otherwise made up of sound stocks that tap into a very wide range of opportunities. Given the category and strategy, some underperformance is to be expected. The fund has gone through bouts of poor performance earlier as well and emerged strong. We are watching performance and will take a call if performance further deteriorates.

Equity – Strategy & Thematic

We are increasingly of the view that adding some thematic funds, if one can time them reasonably, will help generate alpha better than going with just an all-diversified fund portfolio. This view stems from the steadily growing challenges for regular active equity funds to beat their benchmark in recent years. We highlighted in our Prime Funds Review for 2022 on how both the thematic funds we added in 2022 delivered well as their entry was timely. This year too, we would like to focus on such tactical entry points. Towards this, we have made some changes to this category.

We have removed Invesco India Infrastructure that we added in 2021. While the timing of this call was right and it beat the market over the past 6 months, the fund has underperformed peers due to stock holdings that looked sound but did not participate in the ensuing rally. We now want to focus only on specific segments to play the core sector recovery and are therefore removing it. You can exit whenever your exposure (as a proportion of your portfolio) goes 3-4 percentage points more than where you started. 

We have removed Tata Digital. We remain positive about the IT sector, as a contrarian pick. We already have one fund to play this space and are therefore removing this fund to reduce the duplication and make the list more concise. Continue to hold this fund if you are already invested, as its prospects remain good.

We have added Motilal Oswal Nifty Bank Index to add to our already existing active fund from the banking & financial services sectors. For those of you who want to hug the bank index (which continues to outperform Nifty from 2022), this will be a passive route. Thus far, only ETFs were available to play this index. With this, you can go passive. The fund is best bought on market falls (invest on dips). You don’t need this fund if you already holding a banking fund. The banking sector has already rallied well and entry points have to be only on market dips.

We are once again adding ICICI Prudential Commodities. We had given a book profit call on the fund in mid-2022, and asked you to retain the remaining holding in the fund. Therefore, if you hold the fund, continue to do so. This fund is playing the core sector recovery through cement and steel. In our view, the cement sector is undergoing consolidation and a clear recovery. In steel, prospects for local steel demand remain elevated even as global prices may have cooled from their peak.  We expect this fund together with banking funds, manufacturing fund and the transportation fund (the last 2 we already have in the list), to benefit from the core sector recovery.

Hybrid funds

Considering that markets may remain volatile for some time, we have focused on adding hybrid funds that can reduce any fall and deliver equity-linked returns.

Hybrid – Moderate Risk

We have added Quant Absolute, a risky hybrid fund with two-thirds in equity and rest in debt. This fund, similar to funds from the same AMC, takes tactical calls, churning its portfolio often in the process. In debt, though, the fund sticks to safe options such as government securities, deposits and treasury bills. The fund has beat its category convincingly over 1 and 3-year rolling return periods. It will however remain volatile (going by its high standard deviation) and is suitable for high-risk investors.

We have added another differentiated fund - ICICI Pru Multi-Asset Fund. This addition is from the multi asset allocation category, one that we usually avoid. We made the exception in this case as ICICI Pru Multi-Asset not only invests in the usual equity debt and gold asset classes that multi asset funds do, but also chooses commodities such as silver and oil futures, to play tactically. Besides, the fund uses derivatives both in equity (for arbitrage) as well interest rate swaps (in debt). This both contains downside as well as helps add to returns. This ability to go anywhere there is return potential makes it useful to counter poor equity performance in years of market consolidation.

If you leave out Quant Multi Asset, which makes more short-term equity calls to generate returns, ICICI Pru Multi-Asset convincingly beats all other peers and measures up quite well even with the equity hybrid fund category. Treat this fund as part of your moderate risk allocation. Do not try to use it as a one-fund-for-all-asset classes option. It is simply another hybrid fund that can help returns during market consolidation and counter equity risk. The fund tends to have an equity orientation for tax purposes.

We have removed Mirae Asset Hybrid Equity from this category. This fund has seen underperformance since early 2022 but has narrowed it later in the year. Still, its growth-oriented approach (as with other Mirae funds) may see some underperformance in 2023 too, as value continues to gain traction in the market.  We continue to have a ‘buy’ on Mirae Asset Hybrid Equity in our MF Review Tool. You can hold investments made as well as continue existing SIPs. We removed the fund also because we already have two aggressive hybrid funds in the set and we’d like to keep the list concise and make space for the two differentiated funds we added here.

Hybrid – Low Risk

In this category, we removed DSP Dynamic Asset Allocation - one of our trusted funds from the balanced advantage/dynamic asset allocation category. This fund continues firmly on the side of conservatism with low net equity and its risk-adjusted returns remained high. However, it has now slipped over the past 2 quarters and has delivered lower than arbitrage funds in the past year. These comparative lower returns make it less attractive at this time. You can continue to hold this fund for tax efficiency and as a hedge to your equity portfolio. Fresh investments can be done in other funds from our list. The other funds in this set - arbitrage and equity savings (in that order) - will continue to serve the purpose of low risk in equity. 

Debt funds

After reacting negatively to a series of interest rate hikes in 2022, bond markets have taken a breather. Our Prime debt outlook (2023) details what we expect in 2023 and how to go about investing. Our debt funds are fully game to take on moderate rate hikes and flat periods (provided you choose the right bucket of funds for your purposes). While shorter duration yields have moved up pretty quickly, there is also opportunity in the longer duration space if rates begin to fall in the later part of the year or in 2024. Towards this, we have added a fund from the short duration category with high yield but with a higher duration as well.

Debt – Medium term

We have added ICICI Pru Short Term Fund in this Prime Funds set, where we usually house medium duration or corporate bond funds. This fund’s current portfolio YTM is 7.76%. It has well over a third in G-Secs but 12% of such exposure is to floating rate G-Secs. As a result, despite an average maturity of 5.2 years, its modified duration is much lower at 1.5 years. This fund can give the advantage of high yields if rates remain high and also help participate to some extent in any price rally when rates fall. We have added the fund to the medium-term space owing to its higher maturity profile. You will accordingly need the time frame we have specified for this category if you wish to invest in this fund. You don’t need to switch any existing corporate bond funds just for the sake of entering this fund now. 

Prime ETFs

Prime ETFs is our list of recommended ETFs in equity, debt, and gold. We look at multiple factors to draw up this list, ranging from short-term and long-term tracking error, expense ratio, trading volumes and usefulness of the index in a portfolio. In this review, we have made very few changes.

Moderate Risk

We removed ICICI Prudential Nifty 100 Low Volatility 30 ETF under the equity-moderate risk category. This ETF is still good at containing downside but has struggled to beat the parent index meaningfully. You will find more details earlier in this report where we have mentioned the FoF of this index from the same AMC. You can continue to hold the ETF as an option to contain market falls but avoid any fresh investments for long term. You will be better off with a Nifty 50 or Nifty 100 ETF or index fund.

Strategic and thematic

We have removed Kotak Nifty Bank ETF owing to marginally higher market price and NAV deviation compared with Nippon Bank BeES. You can continue to hold this ETF if you own it; do not exit. 

We have added Nippon India Nifty Pharma ETF. This ETF mirrors the Nifty Pharma index, which houses the 20 largest pharma stocks by free float market cap. This is a highly concentrated index with top 3 constituents accounting for over 50%. Pharma as a sector has gained traction as pharma companies have moved from doing just contract manufacturing to taking on end-to-end solutions from research to implementation to manufacturing. While the sector receives lower weight in the bellwether index compared with larger sectors such as banking and IT, it has been gaining ground post Covid with increased focus on medical research. The pharma index underperformed the market in 2022 but this has helped valuation settle to reasonable levels. This ETF is suitable only for long-term investors with a high risk appetite and the ability to take volatility. Mix this thematic ETF along with market-cap based index ETFs.

You can view the full Prime Funds list here.

You can view the full Prime ETFs list here.