Fancy Funds Average Returns

Fancy Funds Average Returns
December 03, 2009 06:45 PM | ShareThis

Mutual fund schemes with fancy names have turned out to be poor performers and pure marketing gimmicks. An exposé by
Debashis Basu & Swapnil Suvarna

Source: Money Life http://www.moneylife.in/article/81/2595.html

As an investor, one of the first things you must remember about fund management is that it is a business. And the revenues and profits of that business have little to do with the returns fund companies make for you. Fund companies earn a fixed fee on the fund corpus—money they are able to gather from investors through various schemes. The higher the corpus, the higher the fees earned. It is not that the higher the returns, the higher the profits. This clear-cut incentive in favour of fattening the corpus has led to a situation where funds have tried to lure investors with fancy schemes. Strange names, and even stranger advertisements, have tried to get investors to part with their hard-earned money. This is because the fund companies did not want to take the more difficult route of explaining the long-term performance of their plain-vanilla equity growth schemes. They floated new schemes to attract fresh money. Fund distributors welcomed this because they got higher commissions on new schemes than on old ones.

It surely looks odd if funds push an investment product exactly the way personal products companies push another version of skin-whitening cream. But even that would have been fine if only their returns were good. We decided to look closely at funds with fancy names and fancy investment ideas. For this unusual analysis, we could identify 78 funds which were sold under names such as IDFC India GDP Growth Fund, JM Core 11 Fund, JM HiFi Fund, HSBC Unique Opportunities Fund, etc.

How have these schemes done against their respective benchmark indices since inception till 30 October 2009? Out of the 78 fancy schemes, 44 schemes underperformed. Even of the 34 outperformers, 16 outperformed their benchmark only marginally (above four percentage points). On an average, these fancy schemes earned a return of 9% while the plain equity funds earned an average return of 19%.

Among the list of fancy schemes, IDFC India GDP Growth Fund, which was launched on 11 March 2009, was one of the worst performers. We are not surprised. There is an inherent fallacy in the name itself. GDP growth is not correlated to stock returns. Stocks deliver returns based on when you buy them, not because the economy is on a growth path. We have written about the paradox of high GDP growth and low returns several times earlier (see Moneylife, 26 February 2009), but obviously fund managers don’t care about this paradox because their returns come from the size of the corpus, not from your returns.

According to its investment objective, the Fund would identify stocks through a systematic process of forecasting earnings based on a deep understanding of the industry growth potential. Since inception up to 30 October 2009, the net asset value (NAV) of this Fund gained 39% while its benchmark index, BSE 500, rose 106%. The top 10 holdings of the Fund include Hindustan Petroleum Corporation, Reliance Industries, Pantaloon Retail (India), Indian Bank, Jagran Prakashan, Bajaj Auto, Sterlite Industries, Educomp Solutions, Bharat Heavy Electricals and ICICI Bank. This looks more like a diversified equity fund launched at the wrong time.

Schemes from JM Mutual always figure prominently in the list of underperformers. Four of its schemes have figured in our list of fancy schemes that have performed awfully since inception.

JM Core 11 Fund, launched on 5 March 2008, is the second-worst performer. The investment strategy of this Fund would appear very tempting, especially to investors who believe in value investing. According to the stated investment strategy, this Fund would have a portfolio of exactly 11 stocks. Each of these 11 stocks would be invested to the extent of 9.09% at the time of purchase. The portfolio would be rebalanced every 15 days to get all stocks back to the limit of 9.09% to prevent any stock going above the targeted concentration range. The Fund also claimed to have strict monitoring criteria under which it would seek to replace certain stocks every six months to prevent stagnancy afflicting the fund portfolio.

The stock selection process was supposed to involve criteria such as three-year earnings growth of 25%, three-year forward price-to-earnings (P/E) ratio of 5x-7x, P/E expansion of 10% per annum and return potential of 100% over the three-year period, a turnover of at least Rs300 crore–Rs500 crore and market capitalisation greater than Rs1,000 crore. What happened to such great methodical stock-picking? The NAV of this Fund since inception was down 38% whereas its benchmark declined 2% in the same period. So what’s the point of having such a complex strategy? The latest top picks in this Fund of Rs289.40 crore were Sintex Industries, MphasiS, IVRCL Infrastructure, Bombay Rayon Fashions, Hindustan Construction, Praj Industries, Diamond Power Infrastructure and Reliance Infrastructure. How many of these stocks have a P/E of 5x-7x and potential for 25% compounded earnings?

The third-worst performer is JM HiFi Fund which was launched on 7 April 2006. This Fund’s NAV has declined 17% since inception while its benchmark index, the Nifty, gained 9%. The investment strategy of the Fund is to “participate in India Building story” by taking exposure to high-growth industries of infrastructure, real estate and financial services sector. The Fund seeks to have a diversified portfolio with allocation to both large-cap and mid-cap stocks. But the portfolio of this Fund projects a different story. In the latest portfolio, this Fund has exposure in Hero Honda. Does this company’s business come anywhere close to infrastructure, real estate or the financial sector? Nitin Fire Protection, Escorts, Sterlite Industries, Nagarjuna Construction and Jindal Steel and Power are among its latest top 10 picks. The portfolio turnover ratio of this Fund has shot up to 2.17 times in September 2009 from 1.15 times in March 2009.

JM Emerging Leaders Fund, launched on 27 July 2009, is the fourth-worst performer. According to its investment strategy, this Fund would try to identify new high-growth businesses at fair valuations and also try to take exposure in companies that are undergoing a turnaround/revival in profits or in stocks that attract a low P/E multiple relative to peers in the same sector. The Fund’s focus is to pick stocks which could “outperform the markets and hence generate a favourable Alpha” due to their high growth potential. Laudable ideas, but only on paper. Instead of generating “Alpha”, its NAV was down 7% since inception, while its benchmark index, BSE 200, has shot up by 18% during this period.
The fifth-worst performer among the list of fancy schemes is JM Contra Fund.

The objective of this Fund is to “invest in a contrarian manner” in equities. This is a medium-sized fund with Rs318.94 crore in assets under management. Possibly, many investors fell for the fancy idea, backed by encouragement from distributors. Its stated objective is to avoid momentum stocks and over-owned sectors, thus “improving risk profile and play on the relative attractiveness of mid-caps and large-caps.” As its prospectus says, “The key is to try and capture at least 80% of up-move in the under-owned stocks.” It’s all bunkum. This Fund was launched on 7 September 2007 when the market was rallying sharply; until 30 October 2009, its NAV declined by 26% while its benchmark index, BSE 500, declined only 4%. The only thing contrarian is its performance. The Fund has a very adventurous portfolio; a quarter of its money is invested in ‘other undisclosed equities and derivatives’. Jaiprakash Associates, MphasiS, Axis Bank, Bharti Airtel, Max India and Suzlon Energy are among the Fund’s latest top picks. The Fund’s portfolio turnover ratio in September 2009 was 1.49 times while, in March 2009, it was just 0.29 times.

No list of underperformers can be complete without a scheme from UTI Mutual Fund. This time, it is UTI Variable Investment Scheme. This is an open-ended scheme with dynamic allocation between equity and debt. Meaning, like a trapeze artist, the fund manager will deftly move from equity to debt and vice-versa. It is a gimmick. Most fund managers are usually good at riding the trend of rising prices. They neither have the mental makeup nor the skills to get in and out of equities. This Scheme is a good example.

Fund companies want you look at the long-term performance. UTI Variable was launched on 7 November 2002. It’s been seven long years. Since inception up to 30 October 2009, the NAV of the Scheme gained just 6% while its benchmark index, the Sensex, gained 27% during the same period. This is not at all surprising because behind fancy labels, lie fanciful strategies. The Scheme’s asset allocation is linked to fixed levels of the Sensex. According to the offer document, the Scheme will take a contrarian outlook on equity investment. For instance, if the Sensex is below 8,000, the exposure to equity would be higher, say 90%. With the upward movement of the Sensex, say to 13,000, the exposure to equity would be scaled down to, say, 30% and, correspondingly, the exposure to debt will move up to 70%. This would result in the Scheme booking profits on sale of equity with every rise in the Sensex by 1,000 points and earning higher interest income with increased exposure to debt. The asset allocation is revised every year on 1st December. Such mechanical and fanciful plans got devastated by the random and wild market movements. This poorly-performing Scheme has Rs19.51 crore in assets under management now; its top equity picks are Reliance Industries, Infosys Technologies, ICICI Bank, Larsen & Toubro and Housing Development Finance Corporation. Its stock selection makes it look like a diversified growth fund and UTI should merge it with one of its plain-vanilla equity schemes.

DBS Chola Global Advantage Fund was launched on 30 May 2005 to invest in Indian companies with export competitiveness and Indian companies which have, or are expanding, their business in global markets. The latest top picks of the Fund include Reliance Industries, United Phosphorus, Glenmark Pharmaceuticals, Dishman Pharmaceuticals, Sterlite Industries, Punj Lloyd and S Kumars Nationwide; many of them are wrong stocks (in terms of global focus and competitiveness) that were bought at the wrong time and price. Since inception, the NAV of this Fund has declined 2% while its benchmark index, CNX 500, has gained 18%. No wonder the Fund size is just Rs6.06 crore.

Fortis Future Leaders Fund was launched to invest in companies with high-growth opportunities in the mid- and small-cap segment, defined as ‘Future Leaders’. Stock selection was supposed to be based on long-term growth and companies “driven by dynamic style of management and entrepreneurial flair.” All these attributes are highly subjective but can be used as a marketing gimmick in a bull market. The Fund has Rs39.14 crore in assets under management, which are invested in Sesa Goa, Union Bank of India, Marico, Opto Circuits, Oriental Bank of Commerce, Cummins India, Oil & Natural Gas Corporation, Maruti Suzuki, ITC and Indian Bank. To call ONGC, Maruti, OBC, Union Bank, Indian Bank as ‘future leaders’ and driven by dynamic style and entrepreneurial flair, is a joke. Not surprisingly, between 2 May 2006, when the Fund was launched and 30 October 2009, its NAV has declined 9% whereas its benchmark index, CNX Midcap, has gained 7%.

LIC MF India Vision Fund was launched on 15 January 2007. The Fund prospectus says that the emphasis will be to pick up undervalued stocks in the ‘mid and small-cap segment’ that have the potential to grow into large-cap stocks in sectors that have been identified as growth sectors. But, of course, the Fund would also invest in large-cap stocks in the identified sectors “only to take the short-term advantage of the market momentum”. Imagine that! A fund manager from the staid underperfomer LIC MF, aiming to take advantage of short-term market momentum. Well, guess what? It neither bought too many small-cap stocks nor did it get into momentum trading. Its latest top 10 holdings are Grasim Industries, Reliance Industries, Bharat Heavy Electricals, Power Grid and Larsen & Toubro. Since inception up to 30 October 2009, LIC MF India Vision’s NAV declined 9% while its benchmark index, BSE 200, gained 5%.

HSBC Unique Opportunities Fund aimed to invest in “companies that have strong fundamentals and possess growth potential but are either temporarily undervalued or are likely to benefit from unlocking of value from the culmination of these ‘out-of-ordinary’ situations that are usually non-recurring and outside the ordinary course of business.” ‘Out-of-ordinary’ conditions may include turnaround/recovery, financial restructuring, distressed debt, spin-offs, asset plays (companies selling at significant discount to intrinsic value), unrecognised growth potential and changes in economic policy, laws and technology.

Since inception, the NAV of this Fund declined 3% whereas its benchmark index, BSE 200, gained 10% during the same period. According to its prospectus, the Fund’s key objective is to ‘Think Differently and Act Early’. Surprisingly, the portfolio does not reflect this at all. It looks like just another equity fund with Reliance Industries, Larsen & Toubro, ICICI Bank, Lupin, Aurobindo Pharma, Bank of Baroda, State Bank of India and Bharti Airtel among its top 10 picks. What is the ‘out-of-ordinary’ situation in L&T, SBI, Reliance and BoB? We were sceptical even when this Fund was launched. You knew what was coming.

As we said at the outset, fancy schemes have turned out to be poor performers and pure marketing gimmicks. On the other hand, plain-vanilla equity funds have done well since inception. The reason is that the fund houses came out with fancy ideas when the bull market was well and truly underway and the fund companies saw an opportunity to sell fancy new schemes to investors. On the other hand, most of the plain equity funds were launched before the massive bull run on the bourses (see chart for reference) that began in mid-2003. In the next bull market, don’t fall for fancy ideas. They are designed to fatten the corpus of fund houses but may end up losing money for you.

Dear All,
Season's Greetings !!!
I wish All IFAs and their family members a Merry Christmas and a Happy and Prosperous New Year 2010.
Regards
G.VENKATAKRISHNAN 24/12/09
Regional Head- SouthTaurus Asset Management Co. Ltd.
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