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Business News/ Money / Calculators/  Why funds underperform despite cash pile
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Why funds underperform despite cash pile

It's not just cash calls that determine a fund's performance. Stock and sectoral selections play a part too

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If an equity fund holds more cash than its peers during volatile or falling markets you’d expect it to fall lesser, giving your portfolio a cushion when others around drop like nine pins? At least that is what we would typically expect from schemes like ICICI Prudential Dynamic Fund (IPDF) and Quantum Long Term Equity Fund (QLTEF), which have more cash holding than their peers. Equity funds usually limit their cash holdings to up to 10% of their corpus.

Compared to this, in the past one year, QLTEF increased its cash levels to 31.4% as per March 2015 end portfolio. Its average cash holding between January 2014 till that time was about 27%. IPDF doesn’t always hold a lot of cash when it wants to avoid equities. It reduced its equity exposure to 74.4% in February 2015 and invested the rest in government securities and money market instruments. While IPDF can invest up to 100% in cash as per its scheme information document (though it restricts cash to 35% of its corpus), QLTEF can hold up to 35%.

Why then, did these funds underperform in 2015? So far this year, IPDF lost about 5% and QLTEF about 4%. They figured in the bottom quintiles when compared to the equity large- and mid-cap category.

ICICI Prudential Dynamic Fund

The fund invests across sectors and scrips in terms of market capitalisation. It also dabbles in government securities and inflation–indexed bonds. It comes with a good long-term track record. But despite low exposure to equities, IPDF has failed to perform in the past one-year period. IPDF follows a top-down as well as a bottom-up stock picking approach.

From July 2014 till about July 2015, it has increasingly held investments in the metals sector. However, in August when global markets fell sharply due to the slowdown in the Chinese economy, metal stocks the world over crashed. As commodities’ prices fell, metal companies—especially producers—bore the brunt. IPDF’s increasing exposure in the metals space backfired.

But S. Naren, chief investment officer, ICICI Prudential Asset Management Co. Ltd is not worried about the scheme’s exposure to the sector. “Metals are trading at one of the lowest valuations on price-to-book (ratio). We believe one should buy it when metals prices are down. And over a period, when metals prices rise, investments will pay off", he said, adding that the sector has seen “eight years of underperformance."

Not all are convinced by this approach of fund managers who tilt their portfolio towards cyclical stocks expecting the markets to recover. “Look, some fund managers have been saying that economic recovery will happen for the past two years now. But when will this recovery happen?", wonders a senior mutual fund analyst at a foreign brokerage house.

The failure of the economy to take off, despite expectations, has impacted quite a few funds, that had restructured their portfolios accordingly. Also, for IPDF, investments in companies like Aban Offshore Ltd, GMR Infrastructure Ltd and Jai Prakash Associates Ltd didn’t pay off as their share prices fell.

Naren refused to comment on specific companies. “We use the counter cyclical approach to pick sectors which have done badly but have a good long-term outlook. In 2007, we exited the infrastructure sector and bought into consumers, technology and pharmaceuticals. From 2008-12, the counter cyclical strategy has helped us. With the same approach in 2014, we invested in utilities, metals, oil and gas, sectors which have been underperforming since 2008 as we believe these sectors have good growth potential over the next three years. Though this has not worked for us in the near term, we are not worried as we have a three-year plus view on our investments. In the past year, the fund has performed in line with the market," he said.

IPDF’s investments in inflation-indexed bonds too haven’t yet paid off, but Naren feels that a low wholesale price index inflation is not sustainable and feels that these bonds would pay off in future.

Quantum Long Term Equity Fund

This is another equity fund that doesn’t hesitate in holding cash when the fund manager feels that valuations have risen sharply. Right from when the equity market started to go up around September 2013 till May 2014, the fund raised its cash levels as others were picking stocks. At the end of May 2014, it held 32.3% in cash. “We had found valuations to be expensive in some of the stocks, forcing us to sell them and raise cash levels in 2014 and early 2015", said Nilesh Shetty, associate fund manager (equity), Quantum Asset Management Co. Ltd.

Cash strategy has been a QLTEF’s cornerstone but it doesn’t just arbitrarily raise cash. It sticks to a bottom-up approach and doesn’t necessarily hold a bias towards a particular sector. Its aversion to sectors like fast moving consumer goods and pharmaceuticals in the past few years has hurt its performance. The sell-off in cyclical and capital goods companies have hurt the fund as scrips such as NTPC Ltd, Oil and Natural Gas Corp. Ltd and ACC Ltd in its portfolio, have dragged its net asset value down. “In a portfolio, not all companies would do well at one particular point in time. Most companies would have a catalyst, which unravels at different time periods. Some stocks would deliver returns in a particular year but these stocks may lag in other years. Similarly, laggards in a particular year may actually drive returns in subsequent years. We try and judge performance over a longer time period", said Shetty.

Usually, its cash strategy has worked. In 2007 on the back of rising a equity market and valuations hitting the roof, it had raised its cash levels in the nick of time. From holding about 1.61% cash at the end of August 2007, it sold off equities and held cash of about 15% towards the end of the year. Though high levels of cash toward the end of the year hurt its performance in 2007, it finished in the top quintile in all the years starting 2008 till 2011. In April and May 2009, its cash levels were just about 4% as it had deployed its equities before the market started to rise. But its long-term returns do not justify its asset allocation strategy, says some financial planners. “And just by virtue of lower expense ratio (1.25%; category average is 2.6%), their returns should look up, which doesn’t seem to be the case," said Manoj Nagpal, chief executive officer, Outlook Asia Capital, a wealth management firm.

What should you do?

It is not just the cash calls that determine a fund’s performance. Stock and sectoral selections also play a part. However, should a fund manager hold cash in the first place or is that an investor’s call? The jury is out on this.

“I prefer to give money to fund managers who will be fully invested in equities at all times. Irrespective of the processes that a fund house has put in place, timing the market is difficult. If I allocate my clients’ money to equities, I would prefer the money to be in equities and not have the fund manager to keep cash", said B. Srinivasan, director, Shree Sidvin Financial Services and Investments Pvt. Ltd. Last week a chief of a mid-sized fund house had visited Srinivasan’s office in Bengaluru and admitted that his fund house took three years to recover from a wrong cash call that they had taken about three years ago.

Both, IPDF and QLTEF are in Mint50 (Mint’s curated list of mutual fund schemes). We suggest you put a halt to your systematic investment plans in these funds for now. We’ll take a closer look at them when we revisit Mint50 in January 2016.

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Published: 04 Oct 2015, 09:04 PM IST
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