Keeping up with difficulty Equity funds in January-June 2009.

Six months may be too short a time to judge a fund’s performance, given that equity mutual funds are intended to be long-term products. But the last six months in the stock market have been so action-packed — the Sensex initially plunged to later gain over 80 per cent from its March lows — that they have proved a good testing ground for equity funds.

Investors may be disappointed to know that mutual funds had a difficult time keeping pace, with only one in four equity funds beating the Sensex or the broader S&P CNX 500 index in this period. This pales in comparison to mutual fund performance in the previous bull runs. In 2007 for instance, four out of five funds outperformed the Sensex.

Here’s an analysis of why some equity funds gained from this rally, while many did not. We take diversified, index and infrastructure funds for individual analysis.

Diversified funds


Less than one in three (50 out of 171) diversified equity funds bettered the Sensex returns from January to June this year. The proportion falls to one in four, if returns are calculated from the March 2009 lows. The figures are similar if one takes the CNX-500 as a benchmark.

An analysis of fund performance shows that three factors helped select funds outperform — low cash positions, exposure to mid-cap stocks and to sectors such as metals, capital goods, petroleum, construction and banks, all of which were out-performers.

On this count, mid-cap funds or those with a large portion of their portfolios invested in mid-cap stocks (less than Rs 7,000 crore market capitalisation) scored as a category.

Cash held: Diversified funds held cash in the range of 10-32 per cent in January this year. The proportion of cash increased in March, when the markets turned volatile. The cash positions in the case of outperforming equity funds was less than 10 per cent in most cases, while the underperformers held over 15 per cent in cash.

Underperformers such as JM Contra fund also had substantial derivative positions, to the extent of 56 per cent in March. JM Basic, HDFC Top 200, HDFC Equity and Principal Large Cap are examples of outperforming funds (5-15 percentage points above the Sensex returns in January-June). They held cash positions of less than 7-8 per cent in January and reduced it progressively to less than five per cent by June.

Reliance Equity and ICICI Pru Dynamic are some of the funds that lagged (by over 10 percentage points), partly due to higher cash positions of 17-24 per cent.


Exposure to mid-cap stocks: Mid-cap funds and those with increased exposure to such stocks outpaced their diversified peers in the six-month period. Funds with portfolios comprising largely (65 per cent plus) mid-cap stocks delivered superior returns. Magnum Midcap, Birla Midcap and Sundaram Select Midcap, which held cash or had some large-cap exposure, upped their mid-cap stocks exposure by 5-20 percentage points in January-June to 68-81 per cent of their overall portfolios.

This apart, these funds also had high exposures to outperforming sectors such as capital goods, construction, metals and financial services. But a mid-cap tilt mattered more than the sector preference. For instance, DSPBR Small and MidCap Fund, with as much as 81 per cent of its portfolio in mid-cap stocks, outperformed despite having defensives such as software, consumer non-durables and pharma as top sectors for these six months.

Reliance RSF Equity has outperformed the Sensex and Nifty with its 40 per cent exposure to mid-cap stocks, despite software, consumer non-durables being the key part of its portfolio during this period.

Kotak-30 and Sundaram Select Focus may have had exposures to all the hot sectors, such as energy, banks, capital goods and construction. But they underperformed the benchmark as they had only around five per cent exposure to mid-cap stocks and also held double-digit cash levels at the beginning of the rally.

Sectoral exposure: Although sectoral exposure mattered less when compared to mid-cap stocks exposure, selecting the right sector was important. The BSE Capital Goods, BSE Bankex, BSE Power, and BSE Metals indices rallied by 47-95 per cent over the January-June period. An exposure to one or more of these sectors of over 15 per cent has delivered, along with right mid-cap stock mix.

Magnum SFU Contra, SBI Bluechip and Franklin India Bluechip are examples of funds that were large-cap oriented, but invested over 15 per cent in sectors such as banks, energy, capital goods and were able to deliver 1-3 percentage point out-performance over the Sensex.

IDFC Premier Equity did outperform the CNX Midcap in the January-June period. But when taken from the March lows, the fund has lagged behind, owing to heavy exposures to defensives such as consumer non-durables and high cash positions.

Despite the market fancy for infrastructure stocks, theme funds focussed on infrastructure had a difficult time beating their benchmark.


Infrastructure funds


Almost all infrastructure funds (except Taurus Infrastructure), for instance, underperformed the BSE Capital Goods index in the January-June period. As a category, all these funds generated just 45 per cent returns during this period, lower than BSE Power or the BSE Capital Goods indices.

Despite the rally in capital goods, power and metals stocks, only some were able to latch on to the opportunity. Sundaram Capex Opportunities and Birla Sun Life Infrastructure are a couple of instances, outperforming the BSE Power index. Reliance Diversified Power Sector, though focussed mainly on power, did better than the BSE Power Index.

But funds such as ICICI Pru Infrastructure, Tata Infrastructure and DSP BR India TIGER did not manage this as they did not take concentrated bets (of the order of 20 per cent plus exposure to select sectors). Instead, these funds took 10-15 per cent exposure to these hot sectors. This, plus significant cash positions of over 25 per cent in January through March (later reduced but still substantial) held them back from participating inthe rally.

Sundaram BNP Paribas Capex Opportunities was the only fund to deliver triple-digit returns in the March-June rally. The fund has upped the exposure to capital goods stocks, from 31 per cent in January to 49 per cent in its recent portfolio.

Index funds


If diversified funds found it a tall order to match the bellwether indices, surprisingly, so did index funds! But ICICI Pru Index Fund Nifty Plan, Birla Sun Life Index Fund, Franklin India Index Fund-NSE Nifty Plan, and Magnum Index Fund were within a per cent of their respective benchmark’s returns.

Of the 17 passive index funds, one fund (ICICI Pru Index Fund - Nifty Plan) beat the Nifty, against which it was benchmarked, helped by 15 per cent of the portfolio being invested in derivatives.

All Sensex benchmarked funds lagged, with some such as HDFC Index Fund Sensex Plan trailing by as much as four percentage points. In many cases, though, the underperformance is of the order of 1-1.5 percentage points. Some funds had 2-5 per cent of their portfolio in cash, which may have widened the tracking error.

The index fund that lagged the most — LIC MF Index Fund Nifty Plan — still had six per cent in cash in its June portfolio, up from 2-3 per cent from January through March