Reshuffle your fund portfolio

When a bull market is in progress, returns of 80, 90 or 100 per cent in individual stocks don’t raise eyebrows.

But when equity mutual funds deliver such returns, it is time to sit up and take notice. And equity mutual funds have indeed put up a stellar performance in the recent bull run with as many as 34 such schemes managing a return of over 70 per cent in the past one year.

But if a fund you own has rocketed, don’t pop the champagne yet. Take a closer look at what drove returns and, more importantly, if the performance has been sustained over the years.

In other words, it shouldn’t be a flash in the pan. Indeed, several chart-topping funds of this rally have not been consistent in delivering returns over longer periods of five years or more. A cogent strategy in stocks and sector choices delivers over the long run than picking momentum stocks.

The recent surge in returns may be as good a chance as you may get to rejig your mutual fund portfolio, to weed out the flash-in-the-pan funds and add to the steady long-term winners. Here is how you can do this.

In the last one year, diversified equity funds as a category have beaten the broader market by a long shot. While the CNX 500 index delivered a one-year return of 39 per cent, equity funds clocked almost 12 percentage points more, at 51 per cent. This margin is much higher than that managed over three- or five-year periods, when equity funds did better than the broader market by just about 3 percentage points.

Roughly a third of the CNX 500 or BSE 500 index stocks have doubled in the year gone by. As a result, funds that picked up these stocks saw their returns zoom ahead of the pack, with stock selection making a big difference to overall returns.

In this bull run, as in previous ones, mid- and small-cap funds shone brighter than large-cap schemes. The BSE Mid- and Small-cap indices returned 59 and 85 per cent, respectively, in the past one year, compared with the Sensex’s 33 per cent.

The mid- and small-cap funds category returned 69.7 per cent during the year, compared with 41.5 per cent by large-cap funds. Multi-cap funds were somewhere in between, averaging 47.8 per cent.

Funds which topped the mid-and small-cap category, and hence the overall return rankings, are Reliance Small Cap, HSBC Mid-cap, ICICI Pru Mid-cap, Sundaram S.M.I.L.E, and Canara Robeco Emerging Equities, with returns of 115 per cent to 90 per cent in the one-year period.

Returns of large-cap toppers in this period pale in comparison with their mid-cap counterparts. But here HDFC Core & Satellite, the best performer, posted a 69.5 per cent return in a year.

Birla Sun Life Advantage, HDFC Equity, Principal Growth, and Escorts Growth followed. Funds that swing between market capitalisations put up a slightly better show than pure large-caps. Best performer Birla Sun Life Pure Value returned 105 per cent in a year. HSBC Progressive Themes, Birla Sun Life Equity, and HDFC Premier Multi-cap were next in line, returning 80 down to 67 per cent.

But investors taking stock of these fund returns today are likely to be caught in a dilemma. Should they bet on the toppers of the last one year or stick to selecting their funds for their long-term record?

Well, investors should give more weight to consistent returns across a full market cycle rather than flash-in-the-pan returns of this particular market move. Taking into account performance across market cycles since 2008, only a few funds of the top performers now have stayed ahead across the cycles.

Consider Reliance Small Cap, the top performer now with a year’s return of 115 per cent. With timely picks such as TVS Motor, Ceat and HSIL, the fund did very well in the one-year period. But having been launched only in September 2010, the fund lacks a track record on which to make a judgment.

L&T Mid-cap, a top quartile fund now, was a third-quartile fund in the 2012 bull market and a mid-quartile fund in the 2009-10 rally. DSP BR Small and Midcap and DSP BR Micro-cap have also posted uneven performances across cycles.

For all these funds, it is better to watch performance for a bit more before buying into them. Those already invested can hold the fund but not add to investments.

But for those who hold HSBC Mid-cap, which ranks in the second spot with a return of 107 per cent, it may be a good time to exit. Adding top performing stocks such as KEC International, NBCC, Gateway Distriparks, Gulf Oil Corp, and Aurobindo Pharma lifted returns. But in 2011, when the market was trending down, this fund lost more value than even its benchmark. On an annual rolling return basis over the past five years, the fund has beaten its benchmark only about 37 per cent of the time.

With large-cap and multi-cap funds too, there are a few which rank high in the one-year period, but slip up based on the long term. For HDFC Core & Satellite, for instance, holding stocks such as Larsen & Toubro, KSK Energy Ventures, Canara Bank, Union Bank of India, and REC paid off. But it hasn’t made the right moves with much consistency; in the past five years, it has beaten its benchmark BSE 200 just about half the time.

Similarly, Reliance Vision’s 56 per cent NAV rise in a year masks an underperformance over the longer term. The fund outpaced its benchmark BSE 200 just about a fourth of the time in the past five years. HSBC Progressive Themes, HDFC Premier Multi cap, JM Core 11 and Escorts Growth are other examples.

In all these funds, you are better off switching out to the more consistent schemes mentioned below. Those considering investing in these funds in the light of their brilliant year’s return can refrain from buying units. Forgoing some short-term gains for stability in returns over entire market cycles is always a good strategy to build a long-term portfolio.

So, which funds should you move into, instead? From the start of 2008 to now, markets have had a bumpy ride. Funds that delivered well in these turbulent markets are good bets.

In the mid-cap and small-cap category, ICICI Pru Mid-cap, Canara Robeco Emerging Equities, DSP BR Micro-cap, ICICI Pru Value Discovery, UTI Mid-cap and Franklin Smaller Companies fared well in this rally. They also have a track record of outperforming markets since 2008. In the multi-cap and large-cap space, ICICI Pru Focused Bluechip, HDFC Equity, HDFC Top 200, Quantum Long Term Equity and Mirae Asset India Opportunities score on the counts of consistently good returns over the years.

Other funds that whizzed their way to the top in this bull run after lying low for years are infrastructure themed funds. Those showing up at the top are Escorts Power & Energy, L&T Infrastructure, Reliance Diversified Power, and HDFC Infrastructure.

Sector plays are risky, requiring timely entries and exits. But those who do want to play these themes can ignore the toppers and instead invest in Franklin Build India or DSP BR T.I.G.E.R, which encompass all sectors related to an economic recovery.

It’s easy to be tempted into investing in funds based on spectacular returns. But since equity funds have to be held over a time frame of at least five years to deliver meaningful returns, the ability of a fund to deliver across time frames matters.