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Source: iStock
Source: iStock

Look beyond the return numbers to know what drives a mutual fund’s performance

Mint50’s annual review evaluates whether or not the chosen schemes pass muster in terms of their return performance and robustness of portfolios

The Mint50 list is not a mere ranking of mutual fund schemes that give the highest returns. It is a curated basket for which schemes are selected on the basis of a quantitative and qualitative evaluation processes.

We looked at the daily rolling return to capture the journey of the fund over a period and not just at one point. Adequate weightage was given to recent performance as well as historical returns. For equity-oriented funds, we went a step further and looked at active return, which a fund generates in excess of the benchmark.

We gave equal importance to the portfolio of funds to understand how the returns were generated. We leveraged the expertise of our data partner, Quantix, CRISIL’s data and analytics platform, to score funds on features such as exposure to sensitive sectors, portfolio liquidity and asset quality to zero in on schemes that passed muster on returns as well as robustness of portfolios (read Methodology). The 16 categories included in Mint50 represent those that we believe will find a place in most investor portfolios (read How to use Mint50).

Every year, we put all the 50 schemes through the wringer again to review their performance and identify stress points that may need to be tracked.

A scheme does not get dropped just because it is not the top performer in its category. At Mint, we believe strongly that chasing top performers is a zero-sum game in the long run, both from the point of view of strategy and the costs and taxes that will eat into any short-term benefits. Staying invested in a fund whose investment philosophy you are comfortable with and giving the fund manager’s calls a chance to play out is a better long-term strategy. But ignoring red flags either in the form of persistent bottom half performance or enhanced risks may affect the expected outcomes.

What we found

The performance and portfolios of the schemes reflected the times we are passing through, both in equity and debt markets.

The lack of breadth in the equity market run-up, which saw indices being driven up to new highs on the back of a handful of stocks, meant that funds with diversified portfolios, especially in the large-cap space, took a beating. Some equity funds, such as the HDFC Top 100 and ICICI Prudential Bluechip and Aditya Birla Sunlife Equity, also found the going tough on account of their investment calls. Returns of others such as IDFC Tax Advantage took a hit due to their higher exposure to small-caps as a long-term strategy.

In the case of debt funds, we found that a majority of them sought the safety of AAA-rated and government securities (G-secs) to shield from the deteriorating credit environment. Funds also took advantage of falling yields by increasing the duration, where possible. With the debt funds space seeing turmoil in the face of downgrades and defaults, fund managers told us about stress tests that they are conducting to ensure safety and liquidity in funds.

This year, we increased the weightage to asset quality and liquidity of debt portfolios given the credit downcycle that we are yet to emerge from and followed up with fund managers on their risk management protocols.

What has changed?

Five schemes changed in Mint50.

Principal Multi Cap is being dropped. A run of poor performance combined with a steady fall in assets under management (AUM) makes it a less desirable choice at this stage. The fund which had maintained a mid- and small-cap focus now has a large-cap focus. While it settles down in its new avatar and proves its credentials, there are other large-cap-oriented multi-cap funds in the Mint50 with steady performance. In its place, we’ve brought in Parag Parikh Long Term Equity that has been a consistent top quartile performer and provides investors exposure to international equities along with Indian equity.

We have also decided to drop Franklin India Focused Equity and Franklin India Smaller Companies. Both funds have seen continuing bottom quartile performance with very few indicators of a turnaround. Moreover, FT is facing a trust deficit as a fallout of its handling of debt fund schemes, which pointed to elevated process and operational risks that allowed the situation to deteriorate to the detriment of investors. SBI Focused Equity takes the place of Franklin India Focused Equity and Axis Small Cap replaces Franklin India Smaller Companies.

The other two changes were on account of higher risk in ICICI Prudential Equity and Debt and ICICI Prudential Regular Savings. We see the debt portion of the portfolio in the hybrid categories as the ballast to offset the risk of equity. High credit risk, particularly in a period of credit quality deterioration, did not sit well with our philosophy for these categories. Both the schemes have very high exposure to AA-rated and below papers and scored poorly on credit and liquidity risk parameters relative to their peers. Instead, DSP Equity and Bond enters the aggressive and BNP Paribas Conservative the conservative hybrid categories.


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What you should do

If you have invested in any of the five schemes that are no longer in Mint50, you have three choices: staying and continuing investments, holding existing investments but switching to another scheme for future investments, or stopping all investments and redeeming the current holding.

If the large-cap pivot of Principal Multi Cap is acceptable to you, then you may leave existing investments and give the scheme time to settle into its new look, but channelize fresh investments into another scheme in the category.

Similarly, you may discount the string of poor performance in FT schemes and give them more time to turn around their performance.

Though chasing top performers is not a sustainable long-term strategy, staying invested in funds that are third and fourth quartile performers for long periods will mean your money is not working as hard as it could. So you should be clear about how much indulgence you’ll allow the fund managers. If the better returns from ICICI Prudential Equity and Debt and ICICI Prudential Regular Savings relative to their peers compensate for the higher risk of holding lower-rated bonds and you choose to take comfort from the issuers and the small holdings in individual securities in the funds’ portfolios as a risk mitigator, then you may choose to stay invested. If, however, you take a dim view of the elevated risks in the “safe portion" of the portfolio, especially in a period of magnified growth and credit risks, you may exit.

The Mint50 audit is our annual exercise to ensure that investors have a pre-vetted set of schemes that meet robust risk and return evaluation parameters. Use the curated list as the basis for the annual portfolio review you must undertake to ensure you are able to meet your goals, most efficiently.

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