Equity funds make sense now

INVESTING

The stock market has turned in a splendid performance this year, driven by excellent numbers from the Indian corporate sector and strong fund flows from foreign institutional investors.

A glance at equity mutual fund schemes shows that most of them have given a return of 25 per cent over a one -year period with some of them even giving 100 per cent. So, is it still a good time to put money into equity mutual funds?

The answer is yes. Here's why:

First, the Indian economy is still growing at 6 per cent and is one of the fastest growing in Asia. Thus, India should continue to see inflows from global investors. Second, Indian companies are now armed with strong balance sheets and leaner workforces and many of them cater to more markets than one and therefore are better hedged.

Thus, companies should continue to do well though the rate of growth could slow down slightly, given that the base is now higher. Fund managers observe that with corporate earnings expected to grow between 13-15 per cent in the next three years, the markets are attractively valued.

Anup Maheshwari, head, equities, DSP Merrill Lynch, is of the view that returns from the market should be in line with earnings growth.

While fund managers are confident about the economy, they feel that the investment approach should not be sector-based but stock-based.

Says Sukumar Rajah, CIO, Franklin Templeton, AMC "long-term investors are better off adopting a bottom-up approach." Maheshwari, too, is convinced that stock selection will be more important than sector plays.

True, a glance at the results in Q205 reveal that not all companies in a sector have turned in equally good performances. In technology, for instance the larger firms have fared better than their smaller counterparts.

Again, some banks like Bank of Baroda saw net profits fall 18 per cent while, HDFC Bank has shown a 30 per cent rise in profit. In the FMCG sector, HLL's recurring net profit dropped 34 per cent, while ITC's profit were up 13.5 per cent.

The same is true for automobiles where Tata Motors saw a 38 per cent growth in profits while Ashok Leyland 's profits fell 18 per cent. Given this, it might make sense to stay put with diversified equity funds rather than invest in sector funds even though some sectors such as technology, power or pharmaceuticals do look promising. 

	Fund size, Rs crore	One-year return as on Nov 11, 2004, per cent
HDFC Capital Builder Fund	217.54	62.66
Franklin India Prima Fund	827.48	53.10
Alliance Equity Fund	225.15	44.67
HSBC Equity Fund	1,401.44	42.61
Kotak 30	182.92	34.76
Birla Dividend Yield Plus	475.89	34.65
Franklin India Prima Plus	347.10	33.81
DSP ML Opportunities Fund	618.34	33.47
Birla India Opportunities Fund	101.88	32.62
Franklin India Bluechip	2,015.39	30.76
Deutsche Alpha Equity Fund	116.59	30.7
HDFC Top 200	633.69	29.98
DSP ML Top 100 Equity Fund	104.20	28.21
HDFC Growth Fund	261.54	27.05
HDFC Equity Fund	1,127.03	25.98
Birla Advantage Fund	417.74	21.59

The advantage with a diversified fund is that you would get the benefit of the best performing stocks across sectors.

The risk of taking a call on one particular sector does seem high at this point since there are huge competitive pressures and not all firms may be able to stay ahead. Should the economy slow down even a little, some of the corporates would definitely feel the pressure on operating margins.

Though fund managers do pick the best stocks from within a sector, they admit that there are not always enough quality stocks in a sector to which one can take an exposure. This sometimes leads them to take larger exposures to some stocks which could be risky.

While sector funds tend to outperform diversified funds when the industry is faring well, the reversal is equally sharp in a downturn, so the timing becomes even more crucial.

Given that the market has already re-rated several sectors such as banking or the outsourcing story in pharmaceuticals, it may be better to invest in a diversified fund. Through such a fund, you can get an exposure to mid-cap and large cap stocks across sectors, thereby reducing your risk.