Mutual mantra

MONEY MAKERS 2005/ MUTUAL FUNDS

An ideal equity portfolio should have a mix of low-cost index funds, powerful sectoral bets and some good actively managed funds.

Nothing can be more true than the fact that actively managed funds as a category will not be able to beat the markets over long periods of time.

As Bogle explains in his much acclaimed book Common Sense on Mutual Funds, investors, as a group, do not, cannot and will not beat the market; and the overwhelming odds are against any particular mutual fund doing so consistently over an investment lifetime.

But don't lose heart, there is still hope. Bogle's remarks are based on the American experience where stocks markets are already in a mature phase. Some experts argue that the Indian markets are still not really efficient; they are still in the evolutionary phase and there is still scope for fund managers to exploit opportunities and beat the market.

The past performance of equity funds do show that actively managed funds have performed better that the market indices. Though, only a few of them have managed to do so consistently through the bull and bear market cycles of the past decade.

Thus, your overall mutual fund strategy has to take into account some of these realities. It can't change every year based on tentative performance. Here are ways to make the best out of mutual funds.

Low-cost funds: A management fee of 2.5 per cent may sound marginal when it is normal for stock prices to go up and down the fee amount on a single day. But over a period of time, even this seemingly marginal cost can erode your wealth substantially. That's one reason why Bogle argues in favour of index funds.

Index funds are typically low cost funds. But in India, index funds, though are less expensive relative to actively managed funds, are still a bit expensive.

We have listed some low cost index funds here. It's worth investing some portion of your investments in index funds as you are sure of getting at least market returns on that portion and you don't pay too much for it.

Long-term performers: Equity funds are for the long term. It's criminal to take a less-than three-five-year view on the markets. However, most people can hardly avoid the temptation to jump into a fund whose net asset value is surging the most.

There is enough evidence to show that going by recent performance may not be a profitable strategy in the long-run. Take for example the performance of equity diversified funds in 2004 compared to their performance in 2003. The top performers in 2004 have been a completely changed lot compared to the previous year.

According to mutual fund tracking firm Value Research, not a single equity fund out of the top 10 performers of 2003 has been able to retain its position this year.

For example, Franklin India Prima, which had returned an amazing 177.13 per cent to grab the top position last year, is down to rank 31 with a return of 21.09 per cent, against 27.56 per cent gain in its benchmark index CNX Mid Cap.

Sitting comfortable at sixth position last calendar year, Reliance Vision has sunk to 89th position. With a year-to-date return of just 11.27 per cent, the 2003 top performer has missed even the diversified category average returns of 15.31 per cent. Of last year's top 10, it's the worst performer this year.

But rewind a bit and one finds that Reliance Vision has actually been the best performers in the past five years with a compounded annual gain of 28.99 per cent. Given that equity funds are for the long haul, it is better to trust your money with someone who has a fairly long record.

Equity fund managers who have managed to beat the index fairly consistently while managing returns way ahead of their benchmark and peers over long periods are K N Siva Subramanium and R Sukumar (Frankline Templeton), Prashant Jain (HDFC Mutual Fund), Madhusudan Kela (Reliance Mutual Fund) and Sanjeev Duggal (HSBC Mutual).

Though past performance is not always an indicator of future returns, given their record, these fund managers look better poised than the others to beat the markets.

Sectoral plays: Sectoral funds can at best be a small portion of your overall portfolio. Sector funds are the best way to play the market if you strongly believe in a particular sector.

But investors need to keep track of the prospects of the sector, as fund managers would usually remain invested in the sector through good and bad times. Some themes which experts are bullish on currently include infrastructure, banking and consumer.

Similarly, the outsourcing theme is also touted to be a major growth area. Investors can consider allocating small portfolio of fund investments in these sectors.

But with sector funds, timing is really the key. Some good picks here may be Tata's Infrastructure Fund and DSP Tiger (the infrastructure growth and economic reforms) Fund and DSP Opportunities Fund.

Closed-end funds: In today's market it's hard to find any stock that trades at a substantial discount to its true worth. But if there is one security in the market which is a true bargain, it's units of Morgan Stanley Growth Fund.

The fund's net asset value is currently Rs 25.49 while its traded price on the bourses is Rs 19.20, a discount of 24.06 per cent.

The fund is due for redemption in 2009 and as the fund ages the gap between its traded price and asset value will minimise. Thus, this fund is a wonderful value buy if you can buy and hold till redemption.

For many investors, Morgan Growth may not sound very inspiring, as the fund was launched with much fan fare but miserably failed in keeping investors belief in mutual funds when the Indian public knew less about funds, much less about closed-funds.

As the fund got listed at a 40 per cent discount to its face value, which is usually the case with closed-end funds, investors panicked. But Morgan Stanley Growth Fund has a fairly stable portfolio which will at least perform in line with the market.

Morgan units are traded in huge volumes on the bourses - about 1,74,000 units daily on the NSE. One interesting point to note here is that while you pay 16 per cent less for the fund, your portfolio is actually compounding at the full value.

In other words, even if you buy units at Rs 19.20, your gains will be on a base of Rs 25.49 (net asset value) on which the portfolio is actually growing. This slight difference in compounding can actually make a substantial difference to your returns.