Is There Life After Death?

By any measure, 1999 was the year of the mutual fund. Riding high on tax exemptions granted in Budget 1999, Indian mutual funds raised more money in 1999-2000 than it had ever done before while crossing the Rs 100,000-crore mark in assets under management. As stocks boomed, and ice (infotech-communication-entertainment) shares soared, there was just one of 143 equity fund schemes-the unfortunate PNB Premium Plus-that showed negative growth in its net asset value (NAV) in 1999. Ninety-four of them outperformed the Sensex, and as many as 71-a whisker short of half-gave over a 100 per cent return!

How different has the new millennium turned out to be. The Sensex is tumbling faster than Jack and Jill and mutual fund NAVS are in free-fall. Suddenly, infotech stocks are being hammered down and every scheme seems to be bleeding. The top-performing equity fund for the year ended April 27, 2000-Alliance Tax Relief 96-showed a NAV growth rate of 214.67 per cent for the year and a negative 25.04 per cent for the last month. Even well-performing balanced schemes-funds that invest in both equity and debt and hence are less volatile-like SBI Magnum Balanced Fund- lost 37.07 per cent of its NAV in the single month ended April 27. Only the gilt funds-investing primarily in government securities-had their necks above water.

So, is it time to get out of mutual funds? And if one is talking about getting out, isn’t it basically about exiting equities altogether? After all, the world over, mutual funds are the best vehicle for small investors to invest in shares. How should investors react to the bloodbath?

Bad Times = Good Times

The answers to these posers are rooted in the first principle of investing in mutual funds-past performance is no guarantee of future returns. The IT-focused funds could hardly have gone on growing at 400 per cent a year till eternity. But then, the pit into which the bourses find themselves currently, too, can’t be bottomless. So, just as it was incautious of the small investor to put his money into any scheme in December 1999, it would be stupid of him to cash in all his chips right now.

Says Niamatullah, managing director, SBI Mutual Fund: "Currently, funds are in a consolidation phase after the recent setbacks. But the longer-term outlook remains bright." Agrees Rajiv Vij, ceo, Templeton Mutual Fund: "The industry is headed for good times. In the last six months, investor perception has been bullish thanks to high returns. The correction is healthy for us. It has brought investor expectation to a more realistic level."

The shrewd investor looks beyond the last month’s soaring (or falling) NAVS to check for consistency in performance. The surge in NAVS in 1999 of many schemes was due to the tremendous re-rating of the software sector with investors acknowledging its global competitive edge and growth prospects. But the entire sector got re-rated-companies doing truly good work as well as firms which were software companies only in name. The advice for the small investor in bad times is the same as it is in the good times: seek funds that have been astute at picking winners consistently and early (and not just in software). Check yearly performance or even better, their three-year performance. For instance, a fund like Reliance Growth saw a NAV appreciation of 66 per cent in the last three months of 1999. SBI Magnum Equity’s NAV grew by 58 per cent. But in 1998, both had single-digit returns.

Ice-Creamed

Investors and fund managers who had accompanied ice scrips on their sustained northward journey during most of 1999 are suddenly feeling giddy, with cash sucked out of their corpus on account of severe hammering by bear operators.

The cruel correction has, besides reducing exposure of bloody-nosed funds to tech scrips, halted the launch of new IT-specific funds. Two new funds bitten by the e-commerce bug-Kothari Internet Opportunities Fund and Prudential Technology Fund-are bleeding almost since inception. Web-specific Kothari Internet Opportunities opened below par when Nasdaq hit its nadir and its NAV now stands at an abysmal 8.34. The fund has logged a negative yield of 12.94 per cent since the start. Prudential Technology Fund, with total assets of Rs 490 crore, has an even more unfortunate scorecard-its NAV is at 6.15 while returns since inception at minus 38.50 per cent.

With the Nasdaq suffering from a major bout of flu since early April, most tech-specific funds have seen their NAVS nosedive. Tech-heavy stalwarts like Alliance and ING, the NAVS of which zoomed during the IT boom, have been hit the hardest. Alliance Millennium Fund, which opened at a strong NAV of 15.29, and shot up to 18 during the Rs 500-crore IndiaWorld takeover by Satyam, is now languishing at a below-par 8.41. This scheme, which was launched recently and has a significant exposure to Satyam Computers, has yielded investors a negative return of 45 per cent since inception. ING, on the other hand, had a large part of its corpus invested in Wipro. With Azim Premji no longer giving Larry Ellison or Bill Gates sleepless nights, the ING fund has also returned to cold storage.

The pressure to perform had forced fund managers to expose as much as 25 per cent of their total corpus to individual IT scrips. Given the average trading volumes of these scrips and the irrational stakes of these funds in such counters, the funds would need 100 trading sessions to liquidate their stock. This realisation has dawned on many players. For example, take a look at one of the biggies in the game, Kothari Pioneer. It has turned a suitor of the Old Economy. The latest portfolio composition of its Bluechip Fund indicates that fresh inflows have been diverted to brick-and-mortar majors.

On February 29, the fund owned 20,000 shares of Asian Paints; by March 31, it owned 50,000. On February 29, it owned 25,000 shares of Mahindra & Mahindra; by March 31, it owned as much as 299,918! In that one month, it hiked its holdings of Larsen & Toubro six times, of ITC more than three times, of Hindustan Petroleum a bit less than three times. Even though net assets of the fund jumped 200 per cent, there was no significant change in the quantities of IT scrips held by the fund. Says Niamatullah: "Funds that can quickly readjust their portfolio strategies will be able to outperform the markets."

The message for the investor: if you are seeking consistent and relatively low-risk returns, funds that are not sector- or industry-centric are the best. Says Pankaj Razdan, vice-president & head, sales & distribution, Prudential ICICI Mutual Fund: "We would advise investors to put a substantial portion of their equity allocation in general diversified funds and a smaller weightage towards sector funds. Also, investors must review their exposure to the sector once in six months."

In the meantime, if you are investing in sector-specific funds, here are some rules to keep in mind:

Of course, all the meticulous planning and research and analysis can’t guard against the imponderables. For example, the budget. Finance minister Yashwant Sinha’s lacklustre budget has left its negative impact on relatively risk-free debt funds. Deletion of Sections 54EA and 54EB of the Income-Tax Act have choked cash flow to these schemes. Both sections offered relief from capital gains tax if investments in debt funds were locked-in for a period of three and seven years, respectively. Since 54EA investments accounted for 15 per cent of debt funds, the withdrawal of relief has left limited investment options for fund managers.

Additionally, Sinha hiked the dividend tax from 10 to 20 per cent for debt funds. Since this means a reduction of about 1.5 per cent in return on investment, debt funds are now facing a liquidity crunch with many investors seeking the exit route. In the month of March, five top debt funds showed annualised negative returns.

The day the budget was announced, February 29, Alliance Liquid Income (Growth) scheme, with a corpus of Rs 845 crore, had a NAV of 14.53. A month later, it had dropped 4.91 per cent to 14.47. Birla Income Plus (Plan B), with a corpus of Rs 1,920 crore, saw its NAV fall from 17.64 to 17.55 over the same period. The story remained negative for DSP Merrill Lynch Bond Fund (Growth), Prudential ICICI Income (Growth) and Templeton Income (Growth). And these were the five best.

On May 3, Sinha announced a number of sops for the software and housing sectors and the next day the Sensex dutifully rose by 218.63 points. But whether the rally will sustain is open to doubt. Anyway, the sops that Sinha announced were expected in his original budget, like not treating esops as perks for taxation purposes and giving full pass-through status to VC funds. One reason why IT stocks fell after the budget was that Sinha did not introduce these measures.

Investment Strategies

Here are some general strategies to keep in mind while investing in mutual funds. First, debt funds. Says R.G. Sharma, chief executive, LIC Mutual Fund: "Right now, there are mixed signals on the interest-rate outlook. Yet, one can confidently say debt schemes will provide better returns than bank deposits." Say Sandesh Kirkire, fund manager, debt, and S.N. Rajan, chief investment officer, Kotak Mahindra Mutual Fund: "What we could see is interest rates at the short- to medium-end of the yield curve remaining soft while the yields at the longer end move up in the latter part of the year. As an investor, we have already reduced our portfolio duration, increasing the concentration of assets at the short- to medium- end of the yield curve."

"A yuppie may want to put up to 75 per cent in equity and 25 per cent in debt as his risk appetite is high and investment horizon long," says Vij of Templeton. "For an older person, this could be reversed."

Though balanced funds are theoretically supposed to have more or less equal exposure to equities and debt papers, soaring share prices ensured that portfolios of most Indian balanced funds were weighted heavily in favour of stocks, often to the extent of 70:30. That composition has been changing fast since the markets started crashing but the investor should be cautious.

Gilt funds are fairly new in India, investing primarily in T-Bills. Credit risk is low, that is, the borrower-the government-is unlikely to default, but there is some price risk since gilts are traded heavily.

For short-term returns, go for money market funds which invest in T-Bills and call money markets. The investment horizon here can be as short as 15 days. Choose the fund based on services-are they offering 24-hour turnarounds, cheque writing facilities and so on? And size: bigger is better.

Mutual Benefit

Even as bourses and NAVS tumble-and perhaps more so in a time like this-mutual funds remain the best way for the small investor to dabble in shares. The reasons, as Razdan of Prudential ICICI lists, are four: risk is diversified, since a fund invests in several sectors; professional management, since most investors may not have the knowledge of markets; services, mutual funds usually offer a far higher level of service than a broker; and costs, there is either a one-time charge or no charge to enter the scheme.

Meanwhile, as the industry matures, the investor too is showing signs of maturity. Says Nikhil Khattau, ceo, Sun F&C Mutual Fund: "In the past, when markets fell, investors moved out of mutual funds. But now investors are moving to debt/balanced schemes from equity-based schemes. Retail investors aren’t exiting but taking a shift." There are enough varieties of funds-and over 450 schemes-to offer the investor as wide a choice as he could possibly want. Just remember: the principles that work in bad times are the same as those that work in the good.