Quarterly review – Changes to Prime Funds & Prime ETFs

Equity funds

Equity markets have remained upbeat, with fresh impetus coming from the US Fed’s big rate cut. We have already explained in detail on how we expect markets to perform in our recent equity outlook review.

In these markets, it’s tempting to juggle your portfolio around to either try to protect it or to capture more gains. We suggest you do neither.

• As always, asset allocation, category allocation and style diversification come to the fore. The reason for bringing in these aspects in a portfolio is to protect downsides and to manage different market cycles. So, if your portfolio is properly allocated, stand by it. Refrain from micro-managing because you’re worried about what markets will do or trying to pick every opportunity there is.
• If your asset allocation is out of alignment (use the Portfolio Review Pro to know what allocation your portfolio needs), only then make the necessary changes. Reduce exposure to what has moved higher than the intended allocation and reinvest in what is low. Where your mid-and-smallcap allocation has moved significantly (by at least 5-7 percentage points from the original allocation), reinvest in large-cap oriented funds if your equity exposure is within necessary limits or in Hybrid – Moderate risk funds if your equity is already on the higher side.
• If you have low exposure to the mid-and-small caps (or even in equity itself), then you can still invest in high-risk aggressive funds. Even if this space has been strongly bullish, your low exposure will limit the impact of a correction. In fact, running an SIP through a correction will be especially helpful for you.
• If you have lump-sums to invest, stagger this over the next 4-6 months. Pick funds that keep your portfolio’s asset and category allocation within necessary limits.

The changes we have made this quarter are as follows.

Equity  – Moderate, active

In this category, we are adding BNP Paribas Large Cap fund. This addition is to provide more fund options that follow the ‘growth’ style of investing. This BNP Paribas fund has been beating the Nifty 100 TRI steadily from around early 2023 on a 1-year return basis. This performance has pulled into the longer-term period as well, with 3-year performance also improving on a steady basis.

The fund’s strategy is a growth-based approach, though valuations are also a factor. It follows a top-down approach, playing on broader themes and drilling down to sectors and stocks that can benefit. The fund’s current portfolio is positioned towards consumption and industrials, which bode well for sustained outperformance over the long term.

Bear in mind that it is best to pair any large-cap based fund along with a Nifty 50 index fund, given that active funds still find it hard to outperform by a significant margin on a consistent basis.

We have made no other changes in this set. Canara Robeco Flexicap, as we noted last quarter, has been struggling. But near-term performance is starting to pick up and its portfolio appears well-positioned to eventually pick up.

Equity  – Aggressive, active

In this Prime Funds set, we are making two changes. The first is that we are shifting Kotak Multicap into this set, from the Equity – High Risk Turnaround. We added this fund in our June quarter review in the High Risk set as it had yet to complete 3 years and we wanted to be cautious. The fund has now entered Prime Ratings and continues to hold up its strong performance.

The second change is to add Baroda BNP Multicap fund. This fund is more aggressive than the other two multicap funds we have in this Prime Funds set. The fund has steadily begun to outperform the Nifty Multicap index over the past few quarters on a 1-year basis. It also sports a consistent record on a longer-term 3-year basis. However, given that it is more aggressive, the Baroda BNP fund tends to fall more and has a higher volatility than the other two multicap funds in our list.

Baroda BNP Multicap follows a growth-oriented style but considers valuations as well. It takes active sector calls and holds a very diffused portfolio with a large number of stocks; individual stock weights are not high. The fund is suitable for high-risk investors, and it is best to add another high-risk active value-style fund or a passive fund along with this in your portfolio.

We are not removing any fund from the list. However, we want to highlight the performance of HDFC Smallcap fund. This fund, earlier a chart-topper, has now dropped below both smallcap category average and the Nifty Smallcap 250 TRI in the past few months. While the underperformance is fairly steep, we are waiting it out for several reasons.

One, the smallcap space has seen a rapid and broad rally, with even companies with poor underlying fundamentals rallying smartly. Most companies have also seen valuations shoot up. For quality-conscious and valuation-centric funds like HDFC Smallcap, this sort of market is a hard one to navigate and will inevitably lead to underperformance. HDFC Smallcap has exited several stocks, for example, besides making minimal changes in several more. It also moved slightly more into cash earlier in the year.

Two, smallcap funds have become extremely erratic in their outperformance over each other or the index making it hard to arrive at any decisive conclusion on consistency or trends. Therefore, we are retaining HDFC Smallcap in Prime Funds. Please note that underperformance may continue for some more time; the fund is otherwise a solid performer and scores well on downside containment.

Given the lack of good, consistent funds in both the mid-cap and small-cap categories, we are sticking to aggressive multicap and thematic funds to bring in high-return options.

Equity – High risk turnaround

In this Prime Funds set, we moved Kotak Multicap out as explained above. We have now added Invesco India Focused in this set. This fund has especially picked up outperformance over the Nifty 500 TRI over the past 3 quarters and has captured upsides well. Part of this performance comes from its good mid-and-smallcap exposure, but it is not the only focused fund to bet on this space; peer funds with similar exposure have not done as well as the Invesco fund. However, given its aggressive stance, Invesco Focused is not the best at either containing downsides or volatility.

The fund follows a growth-oriented approach in its portfolio. But it can also take very contrarian or offbeat calls, given that it aims at picking stocks with growth promise even if the sector itself may be an underperformer or the stock may not be a market favourite.

We are adding this fund in this Turnaround set given the recency of its outperformance, which needs watching, and owing to the higher risk from its focused strategy. If you want to add this fund to your portfolio, start with lower allocations.

Equity – Strategic/thematic

In this category, we are now removing two funds – ICICI Pru Commodities and UTI Transportation and Logistics. You can continue to hold both these funds. Fresh exposure can be avoided for now. 

We added the UTI Transportation & Logistics fund in April 2022, when there was clear sign of the auto story turning around post Covid. A low base helped maximise returns. The annualised returns  for this fund from our call stands at 40.5% as opposed to broad market index Nifty 500’s 22.7% return for the same period. 

With the sector’s scorching earnings growth now stabilising and valuations turning premium, we believe that the entry point is no longer attractive. For those who have already entered the sector, there is still a case for holding, given that certain segments (premium vehicles, two-wheeler uptick) etc can provide some steam. If your exposure to this fund has swelled significantly from your original allocation, you can take out some profits and hold the rest. 

Our history with the ICICI Pru Commodities fund has been more complex. We first recommended it in April 2021, then advised booking profits in June 2022. Following a healthy correction, we reintroduced it to our recommendations in January 2023, believing that global political tensions would cause supply disruptions and keep commodity prices elevated for an extended period.

However, this scenario did not materialize as expected. While precious metals like gold did rally, ferrous and non-ferrous metals such as iron ore, aluminium, nickel, and zinc have all seen a decline in global prices, with copper experiencing only a marginal increase. Energy prices, in particular, have significantly decreased, with the World Bank Energy index falling 33% as of August 2024 from its average level for the quarter ending December 2022.

Despite these global trends, the ICICI Commodities fund benefited from the domestic rally in steel stocks and select cement stocks. From April 2021 to date, the fund has delivered an annualized return of 30.3%, outperforming both the Nifty 500 (22%) and the Nifty Commodities index (26%) over the same period.

Looking ahead, the outlook for the commodities sector appears less promising in the medium term. We’re currently seeing a global supply glut situation for energy and no real shortage in supply for other commodities, which may limit the upside potential for the sector. Given these circumstances, we recommend avoiding fresh exposure to the fund. For those who have held the fund since our first recommendation and haven’t taken profits yet, now might be a good time to consider realizing some gains.

Hybrid funds

We have made only one change in hybrid funds.

Hybrid Equity - Moderate risk

In this category, we are replacing Canara Robeco Equity Hybrid with Kotak Equity Hybrid. While a majority of the funds in this category have been outperforming the Nifty Hybrid Composite index, comparison with peers shows underperformance of many. 

On a rolling 1-year return basis (over the last 3 years), Canara Robeco has beaten peer average only 3% of the times. There can be multiple variables for performance to vary significantly in this category – one allocation to equity and debt; and two within that, exposure to mid and small cap or duration calls. On this count, Canara Robeco’s 73% equity is no different from Kotak.

Kotak though scored on higher mid and small-cap allocation. However, considering that Kotak beats the former over 3-year rolling return as well, we would prefer it for fresh exposure. Those who hold the Canara Robeco fund can hold it and avoid fresh exposure by way of SIPs. They can add Kotak if the prefer marginally higher risk or stick to ICICI Pru Equity and Debt which is already in Prime Funds. 

Debt funds

With the Federal Reserve cutting rates in the US, all eyes are on the RBI’s MPC meeting coming up next week. While the consensus is that a rate cut is required from the RBI, irrespective of what transpires, we have stated in our Debt Outlook review that yield falls are inevitable. 

While many of you may have seen very low returns on your funds in the past 2-3 years, the returns of funds are already reflecting the yield fall scenario. For example, the average 1-year return of corporate bond funds was under 4% in January 2023. The same is now 8.4%. Similarly, from 4% 1-year returns for short duration funds, returns have now improved to 8.1%. 

We have been consciously playing duration in the past few quarters, adding gilts as well as preferring funds with floating rate instruments to curtail volatility - ICICI Pru Short Term and ICICI Pru Banking & PSU Debt are examples. 

Debt funds – Short term & Debt Funds - Medium term

In this category, we have added one more floating rate fund, SBI Floating Rate Debt. This fund has dynamically managed its maturity anywhere between 1-7 years in the past 2 years. It holds majority in gilts and is able to dynamically shift maturities in these instruments. It has beaten its category 76% of the times on a rolling 1-year return basis. This fund is suitable for those with marginally higher timeframe (closer to 3 years or more) than typical short duration funds considering the high exposure to gilts and dynamic change in maturities. 

We have made one more change in the debt space by switching ICICI Pru Short Term Fund from the Debt – Medium Term to the Debt – Short Term category. Instead, ICICI Banking & PSU Debt has moved from the short-term category to medium-term category. This is in line with their residual duration. There is no need to make any change if you had entered with the time frame stated in our earlier classification. The duration at your entry point will only matter.