When in doubt, bring in the professionals. With the equity markets acting difficult over the year, following the investment choices of mutual fund managers would have paid off well.
Consider this. Not only did the average returns put in by equity mutual funds (-7 per cent) surpass that of benchmark indices such as Sensex (-9 per cent) and BSE 500 (-9.5 per cent) in the twelve months to March 2012, but two out of every three of these funds also beat the broader index.
So what did mutual funds do differently to manage this feat? Here's a look at the investment strategies and sector choices that helped these equity mutual funds stay ahead of the benchmark indices.
Diverse options
Lower concentration and play on more number of sectors seem to have stood the mutual funds in good stead.
Overall portfolio of the universe of equity mutual funds was relatively more diversified than that of the Sensex and BSE 500. For instance, while the top five sectors make up about 77 per cent and 64 per cent, respectively, for Sensex and BSE 500, the sector allocations for the equity MF universe were largely diversified. Over the year, the exposure to the top five sectors for equity mutual funds ranged 45-48 per cent; the average was at about 47 per cent (analysis is based on the monthly AUM data for the universe of equity mutual funds as provided by SEBI).
Besides, MFs had spread their eggs across more baskets. While the BSE indices at best enjoyed exposure to about 11-20 major sectors, the sector choices for mutual funds were more broad-based (about 40).
Active management
Active management of sector weights, in keeping with sector dynamics and fundamentals, also helped mutual funds immensely.
For instance, though equity mutual funds and BSE indices allocated the highest exposure to stocks from the banking and finance sector, the weights per se were drastically different. While the overall MF exposure to the sector averaged at about 16.8 per cent in the twelve months to March 2012, that of BSE Sensex and BSE 500 was much higher at about 24 per cent.
The lower allocation to banks helped MFs score as the sector had a modest year. The BSE Bankex index shed about 11 per cent during the period, as against the negative 9 per cent put in by BSE 500.
The leeway from being relatively underweight on banks helped MFs spread their investment across many other sectors. Sectors such as fertilisers and pesticides, for instance, enjoyed a considerable interest from MFs, even as they have only negligible representation in the indices.
This apart, a regular churning of sectors and their weights also helped MFs stay on top of the equity markets. For instance, while on a cumulative basis, IT stocks had enjoyed a high weight of about 8-9 per cent in April-September last year, it was cut down drastically in the following months driven by sector underperformance and partial exits.
In tune with markets
MFs, on an overall basis, seemed tuned to market gyrations and preferences. Telecom and pharmaceutical stocks, which had basked in the attention of mutual funds in the first half of the year (featured in the top-ten list of MF holdings), saw a drastic fall in the months after September 2011. While pharma stocks have had a decent year — the BSE HC Index returned about 9 per cent during the year — the upsides were very stock specific, unlike the previous years.
Besides, high valuations and increasing instances of non-compliance too were beginning to mar the sector's prospects. Pharma stocks, which averaged an exposure of 7 per cent in the six months to September 2011, now make up only 0.2 per cent of the equity AUM.
As for telecom, the sector has been ridden with scandals and regulatory overheads. After making it to the top ten sectors list in July-September, the sector exposure was cut down to less than a per cent thereafter (0.19 per cent in March 2012).
While FMCG enjoyed a significant interest throughout last year, the percentage of exposure was raised gradually. From 6.6 per cent in April 2011, the sector now enjoys a weight of 7.9 per cent. It also merits note that MFs were adept in spotting sector reversals too. For instance, the exposure to power sector was more than doubled in October to 8.8 per cent as the stocks in the sector had corrected significantly then.
Offbeat sector choices that have little or insignificant representation in the BSE indices too have been picked up by MFs. Sectors such as paper and hotels that were in the bottom ten in terms of allocation till about September, now find place in the top ten.
MFs turned wary of derivatives too. Their exposure to derivatives was considerable in March and April of last year (among the top ten), only to be brought down to under a per cent in recent months.