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Are your mutual funds underperforming?

Investors should review their fund portfolios regularly to weed out the laggards.

, ET Bureau|
Updated: Oct 30, 2017, 12.59 PM IST
Investors need to monitor their funds closely, so that they don’t get stuck with perpetual underperformers
Investors need to monitor their funds closely, so that they don’t get stuck with perpetual underperformers
Just as we can learn much from our past mistakes, there are lessons that underperforming mutual fund schemes can teach us.

There are several schemes that have generated negative returns even after holding periods of 10 years.

In addition to identifying these historical underperformers, let us consider the learning from each.

We have considered a 10-year time scale, as within this period, the schemes have got one full down and up cycle to perform. The debt market has also gone multiple interest rate cycles during the period.

Actively managed diversified equity oriented funds, on an average, have outperformed their respective benchmarks.

Actively managed equity funds have done well
The 10-year CAGR analysis shows such funds have outperformed their benchmarks.
Are your mutual funds underperforming?
Source: ACE MF; Compiled by ETIG Database; Data as on 23 Oct

However, there are several schemes that have underperformed their benchmark and investor experience will be based on the returns generated by individual schemes. For instance, several large-cap funds have generated very low returns for their 10-year holding period.

Several large-caps generated very low returns
Shift out of these schemes if the same is not killed by AMCs.
Are your mutual funds underperforming?
S&P BSE Sensex - TRI used as benchmark

Among mid-cap schemes, only Taurus Discovery Fund has underperformed its benchmark. Among multi-caps, UTI Bluechip Flexicap Fund and Taurus Star Share Fund are the underperformers. Investors need not immediately act on these underperformers. This is because mutual funds may use the recent Sebi guidelines on reducing the number of schemes as an excuse to kill the underperformers.

The main learning here is that investors need to regularly review the funds they hold. “Investors need to monitor their funds closely, so that they don’t get stuck with perpetual underperformers,” says Tarun Birani, Founder & CEO, TBNG Capital Advisers.

So how often should one review the funds? “A quarterly review is fine. These are just reviews and there is no need for action. Consider action only if a scheme continuously underperforms for 5-6 quarters,” says Birani.

However, regular reviewers may sense trouble before that. “Investors need to become cautious if any scheme is underperforming the benchmark for three quarters continuously without any valid reason,” warns Melvin Joseph, Founder, Finvin Financial Planners.

To determine the possible reason behind a underperformance, an investor needs to do both qualitative and quantitative analysis. “IDFC Premier was a star performer earlier. Its performance started deteriorating after its fund manager left and that is a valid reason for an investor to shift,” says Ankur Kapur, Founder of Plutus Capital.

Then there are short-term underperforming periods when a fund manager takes a long-term view. HDFC Funds managed by Prashant Jain is a good example. “Since the underperformance by HDFC Funds were due to their heavy exposure to PSU banking and the fund manager was confident of turnaround, we were recommending investors to continue with them,” says Joseph. After the recent recapitalisation decision, HDFC Top 200 jumped 5% on 25 October.

Some fund houses look similar in this segment. With more than 65% equity exposure, the rules mentioned above are applicable for balanced funds as well. Investors should move out of chronic underperformers and remain with temporary under performers.

Some balanced funds have given low returns
Balanced funds good for long term as the debt portion will be tax free after a year.
Are your mutual funds underperforming?
* CRISIL Balanced Fund Aggressive Index used as benchmark

For instance, HDFC Prudence was a temporary underperformer but jumped 4% on 25 October. There are some additional advantages of investing through balanced funds. The main being on the taxation front. Here the debt portion gets taxed as equity. Also, the debt portion induces stability. Some forced rebalancing happens due to this debt portion and that explains why balanced funds as a category was able to generate returns close to that of diversified equity funds.

Several sector and theme-based funds were among the schemes that generated very low absolute returns in the last 10 years. Some of them like Escorts Infrastructure Fund, DSP Blackrock World Gold Fund, etc have generated negative returns even after 10 years. First, lay investors should ignore sector and theme-based funds and stick with diversified funds. “Sector or thematic funds are only meant for ‘evolved investors’ who understand that sector or theme. Other investors follow the herd and invest in them at peaks,” says Birani.

Mutual funds also have to share blame here. During the boom days of 2000, fund houses were busy doling out tech funds. Similarly, several fund houses came out with infrastructure funds in 2007 and investors lost heavily. Sector or thematic funds are for short-term plays and not for long-term wealth generation. This is because sector cycles are short and you can make money only if you get these cycles right.

Overall growth in India is another reason. “The Indian economy is showing overall growth across multiple sectors. Therefore, it will be better captured by diversified funds,” says Arun Gopalan, VP Research, Systematix Shares & Stocks. Lack of diversification is another issue with sector funds. “Retail investors get into mutual funds only for diversification and sector funds defeats that,” says Kapur. Adds Joseph, “Once you select 3-4 sector funds, the combined portfolio becomes like that of diversified funds. Instead of you selecting these sectors, let the fund manager do it; after all, he is paid for that.”

The analysis of index funds has shown surprising results because all index funds had generated less return than their respective indices. Fund houses may argue that these indices are calculated without considering costs and therefore, index fund returns will be less. However, please note that the comparison here is done with the normal index and not with total return index (TRI), which considers the impact of dividends also.

All index funds generated lower returns than the indices
High cost remains a problem with index funds. As actively managed funds continue to generate alpha, this is not a viable option for long-term investors.
Are your mutual funds underperforming?
* Nifty 50 Index used as benchmark; Underperformance would have been higher if TRI used.

Are your mutual funds underperforming?
* Sensex used as benchmark; Underperformance would have been higher if TRI used.

The dividend yield on Sensex is now placed around 1.2% and this under performance happened only because the historical cost was higher than the dividend yields. The high cost is the main problem. “Expense ratios charged by index funds are high and the same need to come down to a maximum of 0.2%. Exchanged traded funds (ETFs) are the better option now,” says Kapur.

As actively managed funds continue to generate alpha, there is no need to look at this category for long-term wealth generation. “Investing in index funds and forgetting is applicable only in developed markets and not in India. Direct plans of low cost funds are much better than index funds now,” says Joseph.

The analysis of debt fund categories has shown surprising results. The 10-year CAGR of long-term income category was only 7.88%, lower than the 7.99% return generated by its benchmark, Crisil Composite Bond Fund Index. As seen in the income funds chart, some of them have grossly underperformed this benchmark also.

Income funds unsuitable for long-term corpus
Use better options like EPF or PPF for parking long term money
Are your mutual funds underperforming?
* Crisil Composite Bond Fund Index used as benchmark.
Source: ACE MF; Compiled by ETIG Database; NAV & returns as on 23
Oct; AUM as on 30 Sep. 10-year CAGR analysis used for all charts.

More importantly, the returns from some of them were very low, even lower than the inflation during the last 10 years. There is need to weed out the dead wood from debt funds using the methods mentioned above.

Second, income funds are for parking short-term money and the same should not be used for parking long-term corpus during the accumulation phase. “For most people, the debt portion is already covered by EPF and PPF, so no need to look at mutual fund for the debt portion. All they need is to have the contingency money in some short-term funds”, says Joseph. “Self employed and business people should use PPF or NPS for parking their long-term money and the debt investments should be restricted to ultra short-term debt funds,” says Kapur of Plutus Capital.

What about MIPs, another debt category with small equity exposure? The category average return of 8.93% beat the 7.9% return of its benchmark, Crisil MIP Blended Fund Index. However, some of them have failed miserably.

In MIPs, equity portion gets taxed as debt
Investors who want small equity exposure should consider equity savings schemes.
Are your mutual funds underperforming?
* Crisil MIP Blended Fund Index used as benchmark

Here again, experts say using MIP for long-term wealth creation is totally unnecessary because the equity part will also get taxed as debt (the opposite of the advantage mentioned for balanced funds). “Equity savings category, which will be taxed as equity after a year, is better than MIPs. Dynamic asset allocation fund is another option for investors with low risk appetite,” advises Birani.

However, debt funds are a good option at the distribution stage—post retirement. “Short-term income funds are useful in the distribution stage because it usually generates better returns than bank fixed deposits and also are much more tax efficient,” says Birani.

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