2016 – a tough year for funds and Select Funds

If 2015 was a frustrating year for equities, 2016 was yet another. Key equity indices – Nifty or the BSE 100 have remained flat over the past 2 years. On a point-to-point return basis, funds linked to these benchmarks did not move much. And our Select Funds, despite holding a solid long-term track record, found it hard to either beat their benchmarks convincingly this year (2016), or seemed lacklustre when placed with their own category in other cases. Here’s a low down on their performance and the reasons for such performance.

Before we move on, we would like to emphasize that equity investing, especially through mutual funds, is a long-term proposition, and from that perspective, they have indeed delivered well. Proof to that lies in the data below, of the 3-year performance of our current set of Select Funds. 

In the essay below, we’d like to take a look at the past year’s performance record of the market, mutual fund performance and performance of funds in our Select Funds list for two purposes – one, as a disclosure exercise, as we like to keep you informed regularly about our fund choices, and two as an opportunity to take an inside look at different segments of the market and how funds made their investment choices in these segments.

2016 performance

Equity funds moderate risk: Our Equity moderate risk category (including tax-saving funds), which is predominantly large-cap focused, delivered an average 4.5 per cent absolute return from the beginning of 2016, till December 15, 2016. It beat the large-cap category average by 100 basis points and the large and diversified category average by 50 basis points. However, the BSE 100 delivered 4.1 per cent thus reducing our margin of outperformance. And the BSE 100 is an important index to benchmark a large-cap oriented fund’s performance.

Why was the outperformance of the Select Funds better when compared with the category but narrower when compared with the BSE 100? One reason is that the stocks that outperformed in the BSE 100 were mostly in the metals and mining category that mutual funds hardly held, given the weak fundamentals.

Vedanta, Hindustan Zinc, JSW Steel (despite its debt burdens) and NMDC to name a few were top performers in the BSE 100. And who held these stocks? Not many of the funds as these are short-term, momentum-driven calls that most fund managers are not comfortable taking. Either closed-ended funds or those that took derivative positions and hedged them were the ones to hold these stocks. Not holding these top performers meant compromising on returns for most funds.

Funds that took very tactical or almost trading bets in sectors such as metals or oil and gas reaped benefits. However, such funds do not figure in our list as they do not boast of any consistent long-term track record.

Another reason for the narrow margin of outperformance with BSE 100 is that funds took positions in sectors such as pharma or IT, either as defensive bets or because valuation looked more reasonable and were not rewarded.

In our own Select Funds list, we gave a long rope to some of the underperformers as our intention is not to frequently change the list based on short-term performance. We gave three funds the benefit of a long-term view and the leeway to turn around. The first is UTI Opportunities where there was change in fund management. The second was Axis Equity where the fund began to recover in the middle of the year against its category and was still holding above its benchmark. The third was BNP Paribas Equity which was hit severely by a few stock calls, especially in telecom. This leeway caused the performance to suffer. We have removed the first two funds from the list in the September review, since we did not see performance recovering anytime soon.

That said, our list had some exceptional performers that not only topped charts but more importantly remained consistent. Funds such as Kotak Select Focus and SBI Bluechip were steady throughout. Others such as Mirae Asset India Opportunities and ICICI Pru Focused Bluechip Equity made a good comeback and managed to finish the year beating the BSE 100 by 4-6 percentage points.

Equity funds high risk: Our equity high risk category, though mostly comprising mid-cap funds, is not as risky in its behaviour as the general mid-cap fund category. The list is a mix of aggressive diversified funds and less-aggressive mid-cap funds.

In this category, as is our overall philosophy, our aim is to provide you with a set of funds that will perform consistently with limited volatility (when compared to its category). While our funds have done that, their relatively conservative approach saw them losing out in the mad mid-cap rally that persisted throughout 2016. And this is reflected in their performance as well.

Similar to large-cap funds, mid-cap funds as a category underperformed the index by a significant margin. Such a trend is rare, as mid-cap funds are usually able to beat their benchmarks by a good margin. So, what happened in this space in 2016?

For one, the Nifty Free Float Midcap 100 index has quite a few large-cap stocks, so to speak, that were hardly held by any midcap funds. It so happened that many top performers for the BSE 100 index were large-caps (from sectors that saw momentum rallies). The BSE 100 story is repeated – stocks such as Hindustan Zinc, JSW Steel and Cairn India were some of the Nifty Midcap 100 index outperformers.

Second, as much of the quality mid-cap rally story was over in 2015, more risky bets took the front stage. Stocks such as Vakrangee, Jubilant Lifesciences, Tata Communications (held mostly only by Birla funds) and Ajanta Pharma delivered extraordinary returns. Very few open-ended funds even held them – similar to what we said earlier about large-cap funds.

Summary of equity performance

Just to summarise, fund managers seem to have been less swayed by short-term chart busters, willing to take some pain and hold sound, reasonably valued stocks, instead of simply chasing performance. This is a marked difference from 9-10 years ago, when funds picked momentum stocks.

The 2016 performance of equity funds, FundsIndia’s Select equity funds and the learnings from the year are:

• Mutual funds refrained from taking short-term tactical outperforming stocks, especially where there was limited fundamental and valuation backing, and missed the rally that those stocks presented
• A year such as 2016 is a trader’s year and fund managers, rightfully, seem to have stayed away from taking risky bets for short-term returns
• Our Select Funds were in line with category in the moderate risk space and more conservative in the high-risk space
• The leeway we gave for underperforming funds to turnaround cost us a bit in the year but we firmly believe that an investor’s portfolio should not be disturbed due to short-term blips

Debt glitters

The good news in the debt space is that debt funds not only beat the poor-returning fixed deposit rates but also outpaced equity as an asset class. For us, while our funds performed well, we have learnt more in the debt space about what credit risk can do to a portfolio, how to handle such risks, when to hold the fund, and when to walk away.

Debt short term: It has always been a challenge to beat debt fund indices, given that they are ‘ideal portfolios’ that cannot be replicated by funds and that expense ratios cut into the marginal outperformance that debt funds do manage. This year, our short-term debt funds matched the Crisil Short Term Bond fund index. They also beat the category average by a small margin. This outperformance is notable because it came about even though we stayed away from the risky, but high-returning funds in the short-term space. Still, funds such as Birla Sun Life Treasury Optimizer, that took tactical duration calls, delivered well in our list. While the near term (last 2 weeks) returns of this fund might cause concern, all you need to do is stay invested for your original time frame to gain.

Debt long term: This category includes dynamic bond, accrual income and credit opportunity funds. Of course, the benchmark, as always, was not easy to beat for our funds and the category in general. Here too, we have stayed away from funds that took extreme duration calls and those that took excessive credit risk. Given these parameters, and that the past year was a good one for funds taking such calls, that our Select Funds still managed to beat the category was a pleasant surprise!

To us, debt is about hedging and providing steady returns. We do not prefer our Select debt funds to post high returns or deliver shocks. While the income accrual funds delivered steady returns, the dynamic bond funds in our list – Birla Sun Life Dynamic Bond and UTI Dynamic Bond outperformed and boosted returns.

What you should read into

If you are going to ask whether you should shuffle your portfolio based on the changes in our Select Funds list, the answer is ‘no’. Your portfolio would have been built with a specific goal, purpose, time frame, or risk profile; and the funds we exit are not ‘sells’ unless we say so clearly. The Select Funds list endeavours to feature good funds at that point in time. Hence, for investors entering afresh, it is a good list to refer. It is not a portfolio by itself.

When we write to you about our quarterly reviews, we make it clear whether a fund that exits our list needs to be exited, or is a ‘hold’. Over and above this, when in doubt, you should talk to our advisors, who will customise the Select Funds list to suit your specific need. Our suggestion would be to use our portfolio review service through our advisors more actively. Not just to choose funds, but also to decide when you want to exit a fund. This way, you will have some assurance on whether you are not making the wrong moves, and you can continue to hold an optimal portfolio.

2016 was a quirky year for the various reasons we highlighted in this essay. 2017 will continue to favour debt. But it could turn out to be the year when equities touch the bottom before reviving. Whether it is the impact of demonetisation on GDP or GST on corporate earnings, all of these will reflect in equity performance and will provide opportunities to average. We would say, hold on and accumulate where possible. We will also sound you off (as we did in the last few months) on opportunities to accumulate.

We will write a more detailed outlook early 2017. Wish you a happy and prosperous new year!

FundsIndia’s Research team has, to the best of its ability, taken into account various factors – both quantitative measures and qualitative assessments, in an unbiased manner, while choosing the fund(s) mentioned above. However, they carry unknown risks and uncertainties linked to broad markets, as well as analysts’ expectations about future events. They should not, therefore, be the sole basis of investment decisions. To know how to read our weekly fund reviews, please click here.