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The Indian mutual fund industry, in the last five years, has come a long way. From net assets of Rs 814 billion ($17.7 billion) in August 1999 to Rs 1.21 trillion ($26.4 billion) in August 2004, the mutual fund industry appreciated by 8.3 percent annually.
But that is only the mutual fund industry asset figures. The returns generated by mutual fund schemes are even more impressive.
This is good news for the Non-Resident Indian who is fast running out of options in the Indian investment space.
At $26.4 billion, the size of the Indian mutual fund industry is a far cry from its US counterpart -- over $7 trillion (September 2004). Of course, you have to discount the fact that the US mutual fund industry has been the preferred choice for investors for several years now. On the other hand, the Indian mutual fund industry is yet to command the same level of confidence and acceptance particularly at the retail level.
Indian corporates for long have found mutual funds a suitable avenue for parking surplus funds. Over 60 percent of domestic mutual fund assets are accounted for by corporates. Retail interest in mutual funds accounts for the balance.
The scenario in mature markets like the US is a lot different. In the US, households take the mutual fund route for a whole lot of life event activities like buying a house, buying a car, child's college education and planning for retirement. This is made possible because there is a lot more breadth in the US mutual fund industry, which has specialized plans for each of these life events.
For instance, the 401 K plan (pension) allows individuals to set aside a portion of their salary (pre-determined by them) for investment in mutual funds (pre-determined by them in association with their employers). So mutual fund-based investment activity is a lot more purposeful.
Why should the NRI exposed to mutual funds in developed markets with custom-made investment plans turn his attention towards a developing mutual fund market in India?
The answer is in the numbers.
Consider for instance, the performance of a leading diversified equity fund in India vis-à-vis that of its counterpart in the US. Over the last five years, Franklin India Bluechip Fund (an open-ended large cap diversified equity from the Franklin Templeton group) has posted 23.3 percent compounded growth (CAGR), while Fidelity Magellan (a leading large cap diversified equity from Fidelity of US that is closed for subscription currently) has declined by 2.5 percent CAGR.
The growth posted by Franklin India Bluechip Fund should not be looked as magical or even freakish. While good fund management played its due role in the fund's superlative performance, the underlying equity instrument is what actually set the pace for the fund's performance.
Over the last decade, stocks of well-managed Indian companies responded positively to the economic reform process that started with renewed vigor in 1991. Fund managers benefited from the fact that the stock market was under researched giving them an opportunity to earn extraordinary returns.
Now the Indian economy is expected to gather pace. This faster growth presents investment opportunities in terms of companies that are best placed to benefit from it. Also, though there is a lot of research happening in India, it is still relatively under-researched. It would thus be possible for the fund managers to outperform the benchmark indices (our preference therefore is for actively managed funds).
The Indian mutual fund industry offers good options to the NRI investor to build a portfolio that can serve his investment interests well over the next 10-15 years, particularly if he plans to return to India.
Few mutual funds NRIs should consider
Our methodology: We have tried to highlight the funds with superior performance track records over the diversified equity, balanced and monthly income plan (MIP) categories. This week we will look at diversified equity funds.
In our selection of mutual funds, we have looked at consistency of performance vis-à-vis peers and benchmark index, consistency in investment strategy, degree of diversification on the equity side and potential to deliver.
We have assessed the fund's performance over several market phases, particularly during market slumps that test the resolve of even the best fund managers. We have gauged all these factors over a period of time after meeting up with fund managers/chief investment officers (CIOs) across several fund houses.
Given that the domestic mutual fund industry is relatively 'young', we have only considered funds with a minimum 3-year history for evaluation.
Diversified Equity Funds
Diversified equity funds are ideal for the risk-taking NRI investor. Typically, NRIs in the 30-50 age group can consider investing in equity funds with the younger NRI (early 30s) having a higher equity allocation as he has time on his side, an important factor to consider while investing in equities.
1. HDFC Top 200 Fund
Who should invest?
Top 200 Fund (HTF) pursues a diversified portfolio strategy and avoids risky investment calls. In this manner the fund attempts to clock above-average growth at moderate risk. The fund has consistently pursued this strategy over the years and has managed to outperform even some of its more aggressive peers over the 3-5 year time-frame. NRIs with a conservative risk profile can consider investing in the fund.
Profile
HTF belongs to HDFC Mutual Fund, a leading private sector fund houses. It previously belonged to Zurich India Mutual Fund, before it was taken over by HDFC Mutual Fund in 2003. The fund's steady performance continued post-merger. Over the last 12 months, its NAV (net asset value) has appreciated by 48.8 percent. Over the last 3 years, it has appreciated by 55.7 percent (Compounded Average Growth Rate -- CAGR).
Investment Strategy
HTF follows a portfolio strategy that can be loosely described as index-plus investing. Typically, this means that its stock selection conforms largely to the Bombay Stock Exchange 200 (about 60 percent of its assets are invested in companies in the index) with the balance 40 percent being invested outside the index. It uses the flexibility of the 40 percent investments outside the index to clock above-average growth.
As on August 31, 2004, HTF had 46 stocks in its portfolio with the top ten stocks accounting for 51.8 percent of net assets. The company's stock picks have been steady, which underlines lower portfolio churn. Sectorally too, the fund is well-diversified across more than 15 sectors.
2. Franklin India Bluechip Fund
Who should invest?
Franklin India Bluechip Fund (FIBF) is managed aggressively and is ideal for NRIs who have a 5-10 year perspective on Indian stock markets. The fund invests predominantly in large cap stocks that are the first to take off in a sectoral upturn.
Investors looking at clocking steady growth from investments in leading Indian corporates across various sectors should consider investing in FIBF given its track record on this front.
Profile
FIBF, a part of the Franklin Templeton Investments offering (earlier Kothari Pioneer Bluechip Fund), is a leading private sector diversified equity fund. The fund was launched in 1993 and is one of the oldest equity funds in the country today. Over the last 12 months, its NAV has appreciated by 56.1 percent. Over the last 3 years, it has appreciated by 52.4 percent (CAGR).
Investment Strategy
FIBF has been aggressive in its investment strategy over the years. It has been quick to identify potential sectors/stocks and has benefited from the upturn in several instances with the tech surge in 1998-1999 being a case in point.
As on August 31, 2004, the fund had 30 stocks in its portfolio with the top 10 stocks accounting for 58.4 percent of net assets. The fund's portfolio today (30 stocks) is more diversified than it was in August last year (23 stocks). Sectorally, the fund is very concentrated with the top 3 sectors accounting for 40.4 percent of net assets.
3. Sundaram Growth Fund
Who should invest?
Given Sundaram Growth Fund's (SGF) conservative fund management style, it will suit NRI investors across risk profiles, particularly those with a moderate risk profile. Its conservative approach makes the fund an ideal long-term investment option.
Profile
SGF is backed by one of the most reliable names (Sundaram Group) in Indian business. Given its style, the fund's performance tends to lag its aggressive peers particularly during a run up in equity markets, but it more than makes up for this slack by holding its own during the bear phase that inevitably follows the bull-run. Over 12 months, its NAV has appreciated by 50.4 percent. Over the last 3 years, it has appreciated by 46.1 percent (CAGR).
Investment Strategy
SGF's stock selection is steady and is marked by low portfolio churn. The fund has investment processes in place to ensure that its exposure to a single stock does not exceed 5 percent of total assets. Likewise it has a 7 percent investment ceiling in sectors. This in turn ensures that the fund is adequately diversified at all times. This is the reason why the fund tends to 'outperform' during a bearish phase as it is never over-exposed to a single stock and this stems the erosion in its NAV.
As on August 31, 2004, the fund had about 42 stocks in its portfolio with the top 10 stocks accounting for 37.3 percent of net assets.
4. HSBC Equity Fund
Who should invest?
HSBC Equity Fund (HEF) offers an above-average risk investment proposition. The fund manager is not averse to taking concentrated sectoral bets and NRI investors who can handle reasonable risk levels should consider investing in the fund.
Profile
HEF does not fulfill the '3 years in existence' parameter set by us. But its impressive performance since inception in December 2002 among other factors merits a mention. Over the last 12 months, the fund's NAV has appreciated by 78.0 percent.
Investment Strategy
HEF has an internal policy that restrains the fund manager from investing over 10 percent in a single stock. As on August 31, 2004, HEF held 66 stocks in its portfolio, which accounted for 98.4 percent of the fund's total assets; the balance (1.6 percent) was held in current assets. HEF was invested across 30 sectors.
Balanced funds
Balanced mutual funds are an opportunity for the NRI to tread the middle path. Investors who have an appetite for some risk, but are wary of taking the 100 per cent equity route through an equity fund, can consider investing in a balanced fund.
Balanced funds, or hybrids, have a mix of equity and debt in a proportion, 60:40 (equity:debt) for instance. The fund manager has the flexibility to manage investments across asset classes and this works well during the bear phase when he can erode losses by shifting assets on to the debt side.
1. HDFC Prudence
Who should invest?: Given its track record, HPF should easily find favor with NRI investors who a medium risk appetite. Aggressive NRI investors can consider investing in the fund to provide some stability to their portfolio.
Profile: HDFC Prudence Fund is an open-ended balanced fund from HDFC Mutual Fund. It was launched in December 1993 and has been a strong performer. It has ranked consistently among the top performers across market conditions. HPF presents an attractive investment proposition and should find a place in most investors' portfolios.
Investment strategy: HPF attempts to religiously maintain a 60:40 (equity/debt) portfolio allocation across market cycles. On the equity side, the fund holds a well-diversified portfolio and is reasonably consistent with its stock picks. In the past, the fund's adherence to a disciplined asset allocation strategy paid rich dividends.
As on August 31, 2004, HPF held 30 stocks in its portfolio, which accounted for 64.6% of its corpus. HPF is also fairly well-spread with its equity holdings in 17 sectors.
On the debt side HPF doesn't take credit risks and invests largely in AAA-rated paper. As on August 31, 2004, the fund held 30.7% of its corpus in corporate debt and govt. securities and the balance 4.7% in current assets.
2. FT India Balanced Fund
Who should invest?: FTIBF should find a place in the portfolio of NRI investors with a higher risk profile. If you are willing to withstand bouts of volatility and stay invested over a long-term horizon, FIBF makes an ideal balanced fund investment.
Profile: FT India Balanced Fund (FTIBF) is an open-ended balanced fund from Franklin Templeton Investments. It was originally a part of the offerings from the Kothari Pioneer AMC, which was subsequently acquired by Franklin Templeton in 2002. The fund has a history of being managed aggressively. But it has justified the higher risk by delivering strong performances.
Investment strategy: FTIBF's mandate permits the fund to invest up to 70% of its corpus in equities and the fund doesn't hesitate to use this flexibility.
As on August 31, 2004 FIBF held 59.2% of its corpus in equities, 26.6% in debt instruments and the balance (14.2%) in current assets. The fund held 37 stocks spread across 21 sectors.
On the debt side the fund holds corporate paper with AAA rating and sovereign paper, thereby granting the portfolio higher safety levels.
Monthly Income Plans
The monthly income plan (MIP) is another segment within the hybrid category. MIPs, which have been the subject of considerable interest over the last 12 months, work on the same lines as balanced funds.
The fund manager has the flexibility to invest a portion of assets in equities, normally in 5-25% range depending on the investment objective of the fund. For NRI investors looking at a regular dividend payout for their parents/children in India, the MIP is an option that needs consideration.
But it is obvious from a lot of skipped MIP dividends in May 2004 that an MIP may not necessarily dish out dividends month on month if the mood in equity markets turns negative. (Investors need to note that MIPs do not assure dividends).
We maintain that NRI investors looking for a regular payout should rather select the quarterly dividend option as opposed to the monthly option to give the fund manager a chance to declare a dividend in volatile equity markets.
FT India MIP
Who should invest?: MIPs fall under the 'balanced fund' category as the fund manager is allowed to invest in equities up to a certain level (20% of total assets in FT India MIP's case), to complement the pre-dominant debt component. NRI investors with a higher risk appetite should use this opportunity to invest in an aggressive MIP like FT India MIP.
Profile: FT India MIP was launched in September 2000 by Kothari Pioneer AMC, a leading fund house that was subsequently taken over by Franklin Templeton in 2002.
Portfolio strategy: Historically, FT India MIP has managed the debt and equity components aggressively. The fund has 20% equity cap (as a percentage of net assets) and one has seen it test this level during the bull run in 2003.
It has an equity component as high as 18.2% of net assets. On the fixed income side, the fund seeks to actively manage the fund based on interest rate movements and credit risk. As on August 31, 2004, FT India MIP had 81.8% of its net assets in fixed income investments with equities accounting for 18.2%.
Its fixed income component compromises mainly of corporate/public sector unit bonds (62.6%), cash/call, bank deposits, money market instruments, and government securities (19.2%).
FT India MIP's rating allocation is largely of the AAA/P1+/Soverign (highest safety) variety (86.7% of net assets) with a fair sprinkling of AA/AA+/AA- paper (13.2%). While the AA/AA+/AA- component is on the higher side, it is the fund's professed investment style to take credit risks.
Principal MIP
Who should invest? Conservative, risk-averse investors who had until now preferred the fixed income route may want to take on a little risk by investing in equities to boost returns. Principal Monthly Income Plan's (PMIP) profile matches the investment profile of a conservative NRI investor who is open to the idea of investing 6-8% of assets in equities.
Profile: Launched in May 2002, PMIP is one of the more popular and successful schemes launched by Principal Mutual Funds. It has delivered a consistent performance drawn largely from a calculated strategy of never exceeding the internal 8% equity cap, although the fund can invest up to 15% of assets in equities.
Portfolio strategy: PMIP pursues a disciplined strategy while managing both the debt and equity components. On the debt side (which accounts for over 90% of assets) the fund maintains a top-notch credit portfolio (largely in AAA paper and government securities) and a conservative average maturity profile.
On the equity side, the fund maintains a diversified portfolio. The stocks (about 15 in number) in the portfolio are not churned aggressively - their primary role being to enable the MIP to outperform a debt fund.
PMIP's rating allocation has a mix of AAA/P1+/Sovereign (highest safety) paper at 73.7% and AA/AA+/AA- paper at 7.9% with term deposits (unrated) and cash/call accounting for the balance.
DSP ML Savings Plus Fund
Who should invest?: DSP Merrill Lynch Savings Plus Fund (DSPF) is suited for NRI investors who are looking for above-average returns (compared to debt funds) and are willing to bear moderate risk by investing 12-15% assets in equities.
The fund falls in the 'middle of the road' category between an aggressive MIP like FT India MIP and a conservative one like Principal MIP.
Profile: DSPF was launched in March 2003 by DSP Merrill Lynch. It has been positioned as an income scheme that can invest a smaller portion (up to 20%) of its corpus in equity and equity related instruments. The fund's performance has been steady and this can be attributed mainly to adept management of the equity portion.
Portfolio strategy: While DSPF can invest up to 20% in equities, its equity investments rarely exceed the 15% cap. The equity portfolio, which comprises largely of large cap stocks is churned aggressively. On the debt side, the fund pursues a relatively conservative investment approach and avoids making aggressive interest rate calls. This cautiousness is underlined further in light of the volatility in debt markets over the past few months.
As on August 31, 2004, the fund had 10.0% of net assets in equities, with fixed income securities accounting for the balance 90%. The debt component was accounted for by govt. securities (8.6%), corporate debt (60.0%) and money market instruments (21.4%).
DSPF's debt paper is predominantly of the AAA/Sovereign/P1+ (highest safety) variety - 61.5% of net assets. The AA+/AA/AA- rated paper accounted for 7.1% of assets with the balance in money market instruments (unrated).
NRIs would have noticed that there aren't any conventional debt/bond funds in our selection. This is mainly due to the fact that debt funds as we know them have an uncertain future. This is more than evident from the performance of this category over the last 12 months.
Also there is nothing to suggest that going forward, the scenario could turn significantly. This is mainly because interest rates in the country have settled down at a level, which is at harmony for a developing economy like India.
Debt funds that relied heavily on falling interest rates to clock capital appreciation have lost their biggest 'ally' and now have to rely mainly on the coupon to generate a return.
Nonetheless, NRI investors with short-term surplus can park their monies in floating rate funds (short term plan) that cut down interest rate risk by investing in floating rate paper.
Floating rate instruments have their coupon rates adjusted at periodical intervals, which reduces price fluctuations arising out of interest rate volatility. Some floating rate funds that NRI investors can consider for investments include Templeton Floating Rate (4.8% over 1-year), Grindlays Floating Rate (4.6%) and HDFC Floating Rate (4.2%).
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