Equity Funds — Ones that missed the bus

A large number of equity funds have failed to match the market indices in the stock market rally of the past year. A compilation of returns shows that 119 of the 256 open-end equity funds in operation (including theme funds) missed the bus in delivering full participation to their investors. These funds recorded a return lower than the 77 per cent generated by the Sensex. So should investors in all these funds head for the exit door? Not necessarily. We put the one-year underperformers through additional filters to decide on the ones in which investors can prune exposure:

Of the 119 funds which failed to deliver the market's 77 per cent gain, 46 were sizeable underperformers, trailing the index by 10 percentage points or more. This shorter list features quite a mix of funds — ones with defensive themes, such as FMCG or consumer stocks; those playing on underperforming sectors, such as telecom or media; one Quant fund and a few tax saving funds.

Of these, investors can hold on to FMCG, Lifestyle, healthcare, media or telecom funds, as their underperformance is simply a function of the underlying sector turning in a sedate returns due to its defensive orientation.

Excluding these theme funds gives us a shortlist of 37 laggards. Of these, however, a few funds deserve consideration for their consistently defensive orientation. After all, funds which trailed the indices this year but contained losses better than the market in 2008, may not be bad bets for conservative investors. Funds such as HSBC Dynamic, Reliance Equity, HSBC Equity, DWS Alpha Equity, Religare Growth and Kotak 30 each of which registered a much lower fall than peers in 2008, may be retained for this reason.

This exercise leaves us with a shortlist of 12 equity funds (See Table). Not only have these funds lagged the market as well as the category average over the past year, they were also less than effective in containing losses to the NAV in 2008. Not all of these funds have been in existence for three years.

Funds that have a three-year record and yet have fared poorly on the above counts may be “sell” candidates at this juncture. JM Hifi, JM Small and Midcap, Fortis Opportunities are funds in this list. Investors in these funds should actively consider exiting them and replacing them with funds with a better recent record.

A few funds with a less than three-year record also feature in this shortlist. Investors in these funds should reduce holdings if they form a large portion of the portfolio. Marginal exposures can be retained with a wait-and-watch approach.