Why some good funds are lagging | Value Research Some of the long-standing category veterans are now at the bottom of the charts, on one-year returns. But don't dismiss them as this is due to their contrarian view on the market
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Why some good funds are lagging

Some of the long-standing category veterans are now at the bottom of the charts, on one-year returns. But don't dismiss them as this is due to their contrarian view on the market

Why some good funds are lagging

Looking at one-year equity fund performance, it is hard to ignore the big divergence in scheme returns. Funds which top the large-cap category boast a return of 13-17 per cent, but the bottom-ranking funds in the same category have only clocked 2-3 per cent gains. In the multicap category, while top performers sport 20 per cent plus returns for one year, lagging funds have gained less than 5 per cent.

This divergence in itself is not surprising. But what is, is that many veteran funds with a very good long-term record are now featuring near the bottom of the one-year return charts. In the large-cap space, for instance, funds such as HDFC Top 200 and ICICI Pru Large-cap are among the low rankers. In the multicap space, we have ICICI Pru Top 100, HDFC Equity, ICICI Pru Dynamic, UTI Dividend Yield, Quantum Long Term Equity and other long-term favourites near the bottom of charts.

So, should investors now exit these veterans and try their luck with newer funds which have topped the charts? This would be a bad idea for many reasons.

For starters, it pays to understand why some good funds have lost out in the last one year, while others have done so well.

Fund returns today are a reflection of the two diametrically opposing views prevailing in the market, about how this bull market will play out.

The defensive argument
One camp (let's call it the defensive camp) believes that there are many risks to the domestic economic recovery, in the form of high corporate debt, bank NPA problems, a slow pace of reforms and profit growth, looming global risks and so on. Fund managers in this camp therefore think that this is not the time to take undue risks.

Therefore, in their portfolios, they have tended to avoid all firms with leverage, vulnerability to economic cycle or an industrial or capex linkage. Their favourites are defensive plays- pharma companies, FMCGs, paints, private banks, engineering multinationals. Any company, in fact that churns out loads of cash, carries no debt and has managed to grow its profits steadily in the difficult conditions of the last few years, is in the portfolio. Now, such stocks are mighty expensive, but these managers are of the view that it is worth paying a high price for 'quality'.

With economic recovery proving slow so far and leveraged companies delivering nasty surprises from time to time, this strategy has worked brilliantly so far. Therefore the stocks owned by the defensive brigade have gone from strength to strength. Thus, quite a few funds from the defensive/quality camp (from houses such as Axis Mutual, BNP Paribas Mutual and IDFC Mutual Fund, to name a few) have outperformed markets and peers by a margin.

The value camp
But there's another value-oriented camp in the market as well. This set of fund managers believe that despite all the pessimism reforms are actually progressing at a healthy clip, economic recovery is set to accelerate and that recent global events such as the commodity price fall, will actually accelerate profits for Indian companies. This camp believes that the rush into quality and defensive stocks is quite over-done. With defensive stocks getting way too expensive, they have been betting on less expensive, but good quality cyclical or industrial names.

They've positioned their portfolios in the large PSU banks, public sector companies and large infra and industrial names. Such cyclical stocks have been quite volatile in the last one year, and have not enjoyed a secular uptrend. The fund managers in this camp have therefore sharply under-performed their defensive peers in the last one year. Some of India's most well regarded fund managers fall into this second camp - Sankaran Naren of ICICI Pru, Prashanth Jain of HDFC Mutual Fund and so on. This is indeed why established funds overseen by these managers, as well as other value-oriented funds such as Quantum Long Term Equity, UTI Dividend Yield and Templeton India Equity Income Fund have delivered such low returns in the last one year.

As you can see, there is a great deal of logic to both arguments. We don't yet know which camp will be proved right. But we do know that sector rotation is in an inevitable part of every new market cycle.

So, if you're a long term investor and would like to participate in the bull market, it is best not to lean too much towards the quality camp and to completely avoid the value-conscious one. By owning only the top ranking funds of the last one year, you would be making this mistake.

Unlike fund managers, you, as an investor, don't have to bet your shirt on just one view of the market. You can remain invested in both defensive and contrarian funds and win either way.


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