August proved to be a testing month for investors as domestic equity markets experienced a volatile phase. Concerns over a poor monsoon and unfavourable global cues, among other factors, had an adverse impact on markets.
However, markets took comfort from better-than-expected Index for Industrial Production numbers and the proposed direct tax code draft. Also, it was a month in contrast. The BSE Sensex shed 0.02%; conversely, the BSE Mid-Cap Index and the BSE Small-Cap Index posted gains of 5.60% and 12.75%, respectively.
Also See India Large/Small/Mid-Cap (Graphics)
Clearly,investors in the mid- and small-cap segments had reason to rejoice. Both, foreign institutional investors (FIIs) and domestic mutual funds were net buyers in the equity markets. While FIIs bought equities to the tune of RsRs4,902 crore, the corresponding figure was around Rs570 crore for domestic mutual funds. From a sectoral perspective, stocks from the consumer durables sector (represented by the BSE Consumer Durables Index—up 5.65%) and the information technology sector (BSE IT Index—up 5.31%) fared the best.
Stocks from the fast moving consumer goods sector were on the receiving end of the monsoon shortfall and its expected impact on rural consumption. The BSE FMCG Index shed 6.74% during the month.
In order to merit funds’ long-term performance, they have been ranked based on their one-year Morningstar risk-adjusted return for this review.
The India Large-Cap category clocked an average risk-adjusted return of -14.1% during the year ended August. Out of 80 funds considered, 39 outperformed the category average. With a risk-adjusted return of 4.2%, UTI Opportunities emerged the top performer. The fund’s net asset value (NAV) rose by 28% over the one-year period.
The Morningstar star rating methodology is based on a fund’s risk-adjusted return denoted as Morningstar risk-adjusted return (MRAR) within a given Morningstar category.
Morningstar categorizes funds based on their average holdings statistics for the past three years. Morningstar uses expected utility theory as the basis for MRAR. The expected utility theory determines how much return an investor is willing to give up to reduce risk.
Therefore, MRAR gives more importance to a fund’s downside deviation. To calculate MRAR, a fund’s monthly total return is calculated. The total return is then adjusted for risk-free rate to arrive at the Morningstar return.The Morningstar return is then adjusted for risk to calculate MRAR. Morningstar uses parameter gamma to describe investors’ sensitivity to risk.
Morningstar fund analysts have concluded that gamma equal to two results in fund rankings that are consistent with the risk tolerances of typical retail investors. Morningstar risk is calculated as the difference between Morningstar return and MRAR.
Morningstar rating is calculated every month for 3-, 5- and 10-year periods. The fund’s overall rating is calculated based on a weighted average of the available time period ratings. Within each rating period, the top 10% funds receive a five-star rating, the next 22.5% earn a four-star rating, the next 35% get three stars, the next 22.5% receive two stars, and the last 10% get one star.
Morningstar rates each share class of a fund separately, because each share class has different loads, fees and total return time periods available. The distribution of funds among the star ratings depend on the number of portfolios evaluated within the category,rather than the number of share classes available.
Graphics by Ahmed Raza Khan / Mint