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In index funds, best strategy is to stay put and play the full cycle: Dhirendra Kumar

There is no credible midcap index fund available, says the Value Research CEO

ET Now|
Updated: Dec 06, 2017, 01.53 PM IST
 For mutual funds, one should be looking at true comparison which will be the SIP return made by the investor compared to an index over 3-5-year period.
For mutual funds, one should be looking at true comparison which will be the SIP return made by the investor compared to an index over 3-5-year period.
Dhirendra Kumar, CEO, Value Research, discusses the best MF Schemes for 2018 with ET Now.

Edited excerpts:

Talking about index funds, when you put in money into a mutual fund, your time horizon is not three or six months, it is much longer than that and hopefully so. But having said that, while we are all celebrating the markets moving above 10,000 barring the intermittent correction that we have had in the last one month or so, not all equity fund schemes have performed well. There have been a fair share of underperformers as well. What do you do? Do you need to go back to the drawing board and revise different strategy? Do you need to exit these underperformers and look at newer schemes?

No, sometimes the best strategy is to do nothing. If you are in a specific plan, do not do much because if you look at the averages, these numbers conceal something. Going by the count, 44% funds are not able to beat benchmark over the last one year. But when you look at the average fund, these numbers will not be reflective of the true investor experience because the fund universe is made up of 250 funds or more, of which top 20 funds will account for nearly 65-70% of the total assets. So, it is a very top heavy listing and one has to see that what is the investors’ experience there. Investors are not disappointed.

If you look at the particular segment which has grossly underperformed the benchmark, and in fact many of those funds are queuing up to stop taking investors money. Many of the midcap funds have been nervous. They have stopped taking lump sum money. Some of them have continued the inflows through SIP and that too with a ceiling on a per folio basis. So the fund managers are not very comfortable taking money or they think that the valuation is not reasonable enough. They have turned conservative while the index does not bother. So one has to look at it on a full market cycle. If there is a market correction and these funds fall as much, it will be taken care of. If you look at all the three-year, five-year, 10-year returns, the margin of outperformance is significant across all categories except for midcaps which actually go on till about five years. It is the average fund performance not matching the benchmark. but the benchmark is also not available to the investor.

You can buy a Sensex fund, you can buy a Nifty ETF or a Nifty Index Fund, but you do not have a credible midcap fund, midcap index available. That apart, 44% of the funds are not beating benchmark even on a one-year basis. This means 56% of the funds are beating benchmark which I think is good news.

For mutual funds, one should be looking at true comparison which will be the SIP return made by the investor compared to an index over three year-five year period because that is the minimum time period for which investor should be investing.That will be the right comparison and on that front things look very bright.

In fact, the worst of funds will be beating the benchmark by a wide margin not because the fund manager will be brilliant but I think the indices are not so smart.

So your advice is then stay put, do nothing and that really would be the best strategy? But let us talk about some of the worst hit pockets. For instance, the midcap schemes include SBI Magnum Midcap Fund, a Reliance Mid and Small Cap Fund, Kotak Emerging Equity Scheme, Motilal Oswal Focussed Midcap 30 Fund, DHFL Pramerica Midcap Opportunities Fund and if I look at the one-year return of the mid and small cap index or the Nifty freefloat midcap 30 as well, they have shown outperformance ranging from anywhere between 44% and 34%. Some of these schemes have been tempered with returns of as large as 31% for Kotak Emerging Equity to SBI Magnum with a 20% return or 25% return for DHFL. Most only give you about 23% to 24% odd return. Do you revisit these schemes or do you have faith in equities that they will make you money and these funds will catch up eventually with the midcap benchmarks?

Yes, I am confident that there is a significant value addition made by a midcap or a small cap fund manager and if you have these funds which are giving a return of anywhere between 20% and 35% - the midcap fund, the underperformers – I do not think it is a full cycle yet for the index because whenever we see a correction, whenever the markets come down, if you look at the breadth of the indexes you know they are the small cap 400 that is the benchmark which will be on a freefall and there will be quality issues.

Also, I feel that there could be reasonable froth in this segment which will go unnoticed and will not be acknowledged or appreciated. The fund managers appreciation of valuation or reasonable valuation with a long-term orientation will yield results. So, there will be just one-year return of the midcap fund compared to index and that may not be the best way of looking at it.

Looking at the multi-cap schemes. however, there seems to be more good news there in terms of how the diversification has helped them catch up with the index returns. Would you hold your bias if it was a choice between large-cap funds, mid-cap funds and multi-cap funds? In this sort of a market environment, should you perhaps go for multi-caps like ICICI Pru Value Discovery, , DSP Focussed 25, ICICI Pru Multi Cap, IDBI Diversified Equity and Reliance NRI Equity Fund?

With mutual funds, all the time we see that the multi-caps are the best way to go for any ordinary investor because the reason one invests in a mutual fund is to gain quick diversification, to gain full access to the market across the breadth of the market and these funds deliver you that.

Investors do not have the wherewithal to really have allocation strategy that this much will be in large-cap, this much will be in mid-cap and small cap. This is the best way to do it and entrust your fund management with complete mandate. And if you look at all the struggling funds, their near-term performance might look disappointing but when you look at 10-year, five-year picture -- you know some of the funds are actually turning very big, their character is changing, their portfolio dynamics is changing.

Circumstance have forced fund managers to manage their fund differently from five years ago, three years ago. They are constrained to function the way they used to. Despite that, when we look at 10-year, five-year returns, things look very bright, very impressive. A degree of outperformance is seen by those actively managed funds which struggled but made it. They make it with their foresight. Look at HDFC Equity, a bet which turned out to be favourable though it was a test of patience. And it is one of the largest where individual investors have exposure. Likewise Value Discovery.

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