The sharp spurt in assets under management (AUM) in mutual funds in recent years appears to have compelled fund managers to venture out of their comfort zone and seek out new stocks to invest in. Such has been the rush into equity that the share of household gross financial savings in shares and debentures (including mutual funds) increased from 2.7% in financial year (FY) 2016 to 10% in FY17.

Equity funds (including balanced funds), in particular, have seen substantial inflows–totalling 5.18 lakh crore in the past five fiscals–compared with 0.2 lakh crore of outflows in the preceding five. This has improved mutual funds’ participation in equity markets, taking the ratio of equity AUM to market capitalisation up from 2.8% as of March 2014 to 6.4% as of February 2018.

The surge in asset flows has also expanded the investment universe of equity fund managers.

Crisil analysed the portfolios of these funds over the past five FYs to understand the relationship between increasing flows and new stocks being added. A universe of about 900 unique stocks was arrived by aggregating the monthly portfolios of these funds for three fiscals–2011, 2012 and 2013. This became the “base universe" for the analysis.

Monthly portfolios of the funds were studied to identify the new stocks and added to this base. For ease of differentiation, we used “new stocks" to include IPOs as well as researched ideas (or “new ideas").

It emerged that more than 250 new stocks were added to the base universe in the past five fiscals, of which over 160 were new ideas.

Fewer new stocks were added when the flows were negative in FY14, while the years following saw an increase. In FY18 (up to February), more than 70 new stocks were added to the universe compared with March 2017. More than 97% of the new stocks added were small-cap stocks—a few beyond the top 500 companies—and the balance were mid-cap stocks.

The spate of IPOs in recent years—especially the last three fiscals—has served the fund managers well in their hunt for new ideas. Among the new stocks that have been added to the universe, IPOs have a sizeable share of 37%. In fiscal 2018, this number was even higher, at over 50% of the new stocks added.

But have the new ideas worked? To find out, the performance of these stocks in the period for which these were in the base universe, was analysed. The performance was measured on a point-to-point basis between the first entry and exit of any new stock to and from the base universe in comparison to the relevant benchmark—the S&P BSE Sensex for large caps, S&P BSE MidCap for mid caps and S&P BSE SmallCap for small-cap stocks. The stocks were classified into large cap (top 100 stocks by market capitalisation), mid cap (101st to 250th stock by market capitalisation) and small cap (beyond the 250th stock) as of the month of their first entry into the universe.

At an aggregate level, (including both new ideas and IPOs), 62% of the stocks have outperformed their respective benchmarks. The outperformance is higher for new ideas (65%) than for IPOs (55%), suggesting the fund managers have got more of their research calls right. Among new ideas, small-cap stocks have been better at outperforming their benchmark compared with mid-caps.

The performance of new stocks shows the investment teams’ success in generating new ideas, for these help differentiate their portfolios and increase the probability of generating alpha over peers and the benchmark, which has, of late, been showing signs of moderating.

The trend in inflows appears unlikely to ebb anytime soon, given that the book size of systematic investment plans has more than doubled in the past two fiscals and awareness of mutual funds has been improving.

It thus becomes imperative for fund houses to beef up their research capabilities further, to be able to identify more and more winning new ideas of their own, supplemented by IPOs. For in the end, how the funds are deployed holds the key to success.

Jiju Vidyadharan is senior director, funds and fixed income business, Crisil Research

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