3 mutual fund trends to show what FY19 meant for investors
4 min read.Updated: 11 Apr 2019, 07:15 AM ISTNeil Borate
Financial year 2018-19 has been a complicated mixed bag for mutual fund investors
One important takeaway (from the trends) is that some debt categories expose you to risk that is not worth extra returns
The financial year gone by, FY19, has been a landmark one for the mutual funds industry as well as investors. The re-categorization of schemes was implemented around the start of the year with schemes moving into category buckets clearly defined by the Securities and Exchange Board of India (Sebi). Around halfway through the year, problems in certain corporate groups and their consequent debt defaults or downgrades shook the industry, particular debt funds which held troubled papers. Interest rates rose sharply in the first two quarters of FY19, but moderated and reversed in the last two, spurring a rally in long-duration funds, even as their credit risk peers languished. In equity, large-cap funds put in a respectable performance even as mid- and small-cap funds failed to deliver.
All in all, FY19 has been a complicated mixed bag for mutual fund investors. We cull out three trends that emerged in the industry.
Indices, large-caps ruled the roost
On the equity side, the Nifty and the Sensex led the pack, carrying exchange-traded funds (ETFs) along. The S&P BSE Sensex gave a return of 17% in FY19, while the Nifty gave 15%. ETFs tracking the Sensex gave 16-18%, while those following the Nifty gave 14-17%.
Within actively-managed funds, HDFC Top 100 stole the show with a return of 17.16%, followed by Axis Bluechip (14.53%) and Reliance Large Cap (14.29%). Despite the relatively narrow universe Sebi chose for this category, the divergence between large-cap funds was large. For example, HDFC Top 100 gave 17.16% and IDBI Top 100 just 4.10%.
Mid- and small-cap categories languished, clocking average losses of -1.18% and -7.72%, respectively. However, in what re-establishes the importance of fund selection, there was huge divergence in returns from funds within categories. Among mid-caps, Axis Midcap Fund gave 9.11%, while Baroda Midcap Fund -6.31%. In the small-cap category, Quant Small Cap Fund gave 0.94% compared to -14.29% for Sundaram Small Cap Fund.
“Last year was not a broad rally," said Amol Joshi, founder, PlanRupee Investment Services, a financial planning firm. “It was led by a select group of stocks and some of last year’s outperformers did well by heavily investing in these stocks. But we cannot do a straight line extrapolation from that. Continued outperformance depends on how the fund manager responds to changing market conditions," he added.
ETFs, especially smart beta ETFs, gave varied performance. Smart beta ETFs follow a particular investment strategy. ETFs tracking the NV 20 Index (Nifty 50 Value 20 Index) of 20 value stocks in the benchmark Nifty gave 24-25%. On the other hand, smart beta ETFs tracking the Nifty Next 50, a collection of 50 companies immediately following the 50 largest listed companies, gave almost nil returns.
In debt, duration trumped credit
The FY began inauspiciously for long-duration funds which are more sensitive to interest rates than accrual funds. Interest rates rose on the back of a rising rate cycle, higher crude oil prices and tightening global liquidity. Oil prices began rising in mid-2017 and peaked at around $85 a barrel (Brent crude) in October 2018. At the time, credit funds were seen as the safe haven in the debt category. The picture reversed around September 2018, when the IL&FS crisis hit the industry and spread to groups like Essel and DHFL.
Debt funds which had taken aggressive credit bets with these groups were hit hard by downgrades or defaults. On the other hand, interest rates fell due to softening inflation rate, pushing up returns on long duration funds.
However, returns varied significantly from scheme to scheme. In the credit risk category, for instance, Franklin India Credit Risk Fund gave 8.51%, while Invesco India Credit Risk Fund gave -3.11%.
“It is difficult to say if the trends of FY19 will stay. However, one important takeaway is that some debt categories expose you to risk that is not warranted by the extra returns they give. I would place credit risk funds squarely in this bucket," said Deepali Sen, founder partner, Srujan Financial Advisers Llp, a financial planning firm.
Hybrid Funds combined worst of both worlds
Hybrid funds are supposed to combine the stability of debt with the growth potential of equities. In FY19, they seemed to have combined the worst of both categories with their returns falling below what either category has delivered.
Hybrid funds seem to have piled into mid- and small-cap stocks, much to their detriment. On the debt side as well, they failed to capture the rally in government bonds. However, outliers remain.
What lies ahead: The industry recorded net inflows of ₹1.09 trillion for FY19. The vast majority of these inflows were in equity funds. However, net inflows in equity funds peaked in November 2018, before dipping sharply in the months that followed. On the regulatory side, Sebi abolished upfront commissions in favour of an all-trail model as well as cuts in the total expense ratio (TER) that mutual funds are allowed to charge, effective 1 April. FY20 will see this play out. Starting with these cuts and a general election, FY20 promises to be every bit as impactful as the financial year gone by.
What should you do? The returns of different market segments can diverge significantly. It is important to be diversified, provided your risk profile allows you to capture returns across the market.
Don’t risk your capital for a little bit of gain, especially for certain types of debt funds like credit risk funds. “People invest in debt funds thinking they’re safe and only look at yield. After the incidents with ILFS, DHFL and Essel, investors should take home the fact that it is more important to look at credit quality as it is to look at yield. Also, low credit quality funds, typically, come with higher expenses," said Mrin Agarwal, founder-director of Finsafe India Pvt. Ltd. Also, remember that hybrid funds do not generate regular income.