Growing size of equity schemes may result in moderate returns, say fund managers

For the time being, the high return phase of the past three years appears to be over

It’s been a good going for India’s equity mutual fund investors. In the past three years, they have made returns in access of 20 per cent, while inflows remained strong. Equity asset size has more than doubled, while nearly eight million new equity accounts have been opened as expectations of returns remain high. But it’s time to tone down your return expectations and expect reasonable gains, at least from a two-three years perspective.

The burgeoning size of India's several equity schemes amid exceptionally higher benchmark beating returns, especially in the past three years, have made fund managers cautious about the sustainability of such trajectory of returns in the future. 

Over the last three years, India's key stock indices have gained 12-14 per cent on an annualised basis, while the average return made by country's ten largest equity schemes is above 26 per cent.

Fund managers believe, that going forward, outperformance is likely to get moderated and investors should be ready to see rationalisation in returns. The cautious warning comes at a time when retail investors have stoked nearly Rs 2 lakh crore in equity-related and balanced funds since the middle of 2014.

Sankaran Naren, chief investment officer (CIO) of India's largest asset management company ICICI Prudential Mutual Fund, says, "Over the past three years, alpha generation against benchmarks of many large schemes has been higher on account of the good performance of their mid and small cap exposures. Given that this segment has run up, we believe that the alpha generated may moderate in future. As schemes become larger, the concentration of portfolio also has to reduce and number of stocks has to be higher."

The fund house has three schemes from its stable which have made it to the list of India's ten largest equity schemes —  ICICI Prudential Value Discovery, ICICI Prudential Focused Bluechip and ICICI Prudential Balanced Advantage. Put together, these schemes have an asset size of Rs 40,412 crore as on 31 August.

Mahesh Patil, co-CIO of Birla Sun Life Mutual Fund, who manages India's fourth largest equity scheme Birla Sun Life Frontline Equity (Rs 13,634 crore), echoes the same sentiments. He says, "The last three years have been quite good from the schemes' outperformance point of view. However, going forward that will normalise. Size of a scheme can be a constraint but it has to be seen in relation to the investment style and strategy of the scheme. Liquidity can sometimes be challenging in large schemes, which tends to have some kind of impact on the performance. However, I believe that schemes will continue to outperform benchmarks but with a slight drop in margins. If you see the year 2014, outperformance against benchmarks was huge. That phase is now out."

But he is confident that in the long term, there are possibilities of higher alpha returns as he believes that the market still offers enough bottom-up stock picking opportunities. 

It is important to note that out of the Rs 5 lakh crore of equity assets which the fund industry currently manages, nearly Rs 1.9 lakh crore, or about 40 per cent, of assets are only in the top 20 largest schemes. If fund managers' views of moderation in returns turn out to be true, a sizeable chunk of equity assets will not perform the way they performed over the last three years.

However, there are fund managers who think that size should not always be the cause of underperformance and that there is still merit in active fund management space, of which Indian fund managers have now a decade-plus expertise.

Sunil Singhania, CIO, Reliance Mutual Fund, says, "Size may not be blamed as the only factor to impact the schemes' capability of beating the benchmarks with a healthy margin. There could be circumstances when there is a sudden rise in inflows in certain schemes and it becomes an issue to deploy all the cash into the markets. Schemes which gain size gradually do not generally face much of this issue, but those which see sudden and undesirable inflows during a certain time may find it difficult to perform far better than the benchmarks. In India, I do not think schemes with an asset size till $2 billion should be constraint with its size. Beyond that, there could be some constraint as some anecdotal instances suggest. But I feel that active management space still has merits and schemes, despite big size, can generate five per cent alpha returns against benchmarks in the long run." Three of the Reliance MF's schemes – Equity Opportunities, Growth Fund and Tax Saver Fund – have made to the top 20 list of largest schemes.

According to Prashant Jain, CIO, HDFC Mutual Fund, the size of the funds should be looked at in the context of the market fund managers are dealing in. Earlier, Jain had said to this paper, "I think, size in absolute sense has little meaning. What matters is relative size. In the developed markets, MFs have become so big that they are a very large part of the market and hence the worry comes about size of funds. But in India, we are far away from that situation and size is not a constraint. That time will come in India too and then we will not complain about investors' education but about performance. The result of it will be investors would go for passive funds which are cheap and returns are not less."

HDFC Equity, HDFC Top 200 and HDFC Mid Cap Opportunities are among the top largest schemes of the country, managing a collective asset of a little over Rs 42,000 crore.



Data of 1 year, 3 year and 10 year return is in per cent.
Source : Value Research Online