Equity fund returns may slow

It would be an understatement to say that mutual funds had a good run in 2005. New fund offerings in the equity segment alone had seen an inflow of more than Rs 25,000 crore (Rs 250 billion), while the total assets under management of the industry has grown by 35 per cent in 2005. But that is beside the point.

The thing is investors in equity mutual funds enjoyed a jolly good time in 2005, with even the worst performing category managing annual average returns of close to 20 per cent.

The best performing category during 2005 has been FMCG funds, which gave a return of 64.56 per cent during the year. Tax planning (50.54 per cent) and technology funds (50.44 per cent) were next in line, while diversified funds managed a return of 47.10 per cent. Even the least impressive equity category, petroleum funds managed a return of 19.29 per cent in 2005.

For those who thought 2004 was a good year as far as equity fund returns are concerned, the good news is that 2005 is even better. Compared to the average return of 47 per cent in 2005, diversified funds managed only 26.70 per cent in 2004. However, in 2003, when the current bull run started diversified funds managed a whopping 110 per cent.

What is in store for 2006? Fund managers note that things are unlikely to be as good as in the past two years. Still the good news is that equities should continue to give returns which are better than any other asset class, stray cases apart.

There is a reason behind such optimism. One obvious reason is that fund managers continue to bet on the India growth story. Despite worries non several quarters about India's high valuation vis-a-vis other emerging markets as well as the fact that corporate earnings growth has been slowing down in the past few quarters, fund managers remain bullish.

According to Nilesh Shah, chief investment officer of Prudential ICICI Mutual Fund, the fundamentals of Indian equity markets are still attractive.

"The economy is on a good wicket. Indian economy managed a growth of 8.5 per cent in the first half of current fiscal and considering the fact that second half is usually better than the first, even on a conservative estimate, we can hope to achieve a 7.5-8 per cent growth for the full year," he says.

Shah also feels that worries about FII inflows - which crossed the $10 billion mark recently - slowing down are out of place. "Several new investors, especially from regions like Japan, Middle East, Australia and Germany are entering the Indian markets for the first time, which should ensure that inflows continue in 2006 too."

Indian equity valuations, even at the current levels are also reasonable, feel fund managers. Anup Maheshwari, chief investment officer of HSBC Mutual Fund notes that current valuations are close to historic average valuations. "So as long as there is good earnings growth stocks should take care of themselves," he says.

Despite the optimistic mood, fund managers seem convinced about one thing. That is equity returns are unlikely to be as high as they have been in the past couple of years. Says Shah, "Investors should pare down their return expectations. Given the larger base and a stable interest rate scenario, corporate earnings growth may be steady rather than spectacular. This is bound to get reflected in equity returns too." The consensus is that equity fund returns will be more or in line with that of corporate earnings growth at around 15-20 per cent.

Shah notes that how investors approach their equity investments will depend on their risk appetite. "If one is looking for safety, then it is better to go for large-caps. However, even at this levels, growth is likely to come form the mid-cap segment, though the risk is definitely higher there."

His advice is to keep a diversified portfolio so as to mitigate undue risk. As far as sectoral allocation is concerned, Shah feels that a sector fund exposure should be considered only as an add-on to one's portfolio. He is bullish on the non-ferrous metals, technology and select pharma counters.  One sector which is not on the fund managers' radar right now is the oil and gas segment.