Category: Investing Insight

Investing insight to make you a better investor.

Choices: Large-cap Investing

While looking at investing in large-cap stocks, investors have quite a few options available to them.

Mutual Funds

Previously, we discussed ‘Top 100’ funds — funds that invest in the largest market-cap stocks. This is one way to go about adding large-cap exposure to your portfolio. However, the expense ratios of more than 2% will eat into your returns. Remember, returns are not predictable, but fees are forever.

Passive ETFs

You can buy an equal proportion of the NIFTYBEES and the JUNIORBEES ETFs. Since these are exchange traded, you don’t have to go through the hassle of “surrendering” your mutual fund “units” and keeping track of exit-loads etc. Besides, NIFTYBEES’ expense ratio is 0.5% and JUNIORBEES’ 1%. Overall, you pay 0.75% to Goldman Sachs to manage the ETFs.

Not a bad deal, considering that you end up tracking the CNX 100 index which represents the top 100 stocks by market cap.

Active ETFs

We have a Theme that takes a tactical route when it comes to tracking the CNX 100 index. Its called the CNX 100 50-Day Tactical Theme. The basic idea is to switch between (NIFTYBEES + JUNIORBEES) and LIQUIDBEES depending on whether the CNX 100 index is trading above or below its 50-day moving average. Details of the strategy can be found here.

The drawback is that in flat markets, you end up getting whipsawed a lot. But if you have the discipline to stick with it for over 5-years, it has the ability to deliver superior risk-adjusted returns.

Conclusion

Each of the approaches described above have their advantages and disadvantages. With mutual funds, you have a brand-name manager who is working for you. With the passive route, you save on fees. The tactical route will probably lessen drawdowns during a market crash and preserve capital.

What you end up investing in finally boils down to whatever sails your boat.

Comparison: Top 100 Funds

Large-cap stocks

Large-cap stocks are less volatile, ceterus paribus, compared to mid-cap and small-cap stocks. For most first-time investors, the set of Top 100 Funds offers a straight-forward way of adding equity exposure.

Fund/Scheme IRR (2014) Expense
Birla Sun Life Top 100 Fund -Growth Option 48.27% 2.82%
ICICI Prudential Top 100 Fund – Regular Plan – Growth 37.71% 2.77%
IDBI India Top 100 Equity Fund Growth 40.05% 2.87%
UTI – TOP 100 Fund- Growth Option 40.68% 2.43%

Picking the right scheme

Birla Sun Life Top 100 Fund -Growth Option.performance

As an investor, you should care about two things: risk-adjusted returns and expenses. While the Birla fund gave better returns, it charged a higher fee compared to UTI. But are those higher returns sustainable? Investors should be willing to pay more for more. This is where the FundCompare tool can help.

Birla vs. UTI

Birla vs. UTI Top 100

Between 2009-07-01 and 2014-12-29, Birla Sun Life Top 100 Fund (Growth Option) has returned a cumulative 155.00% with an IRR of 18.56% vs. UTI TOP 100 Fund (Growth Option)’s cumulative return of 108.35% and an IRR of 14.28%.

On the face of it, Birla’s higher fees seems worth it. But it looks like higher returns came at the expense of higher risk. Birla’s beta (vs. CNX 100) is 0.90761 vs. UTI’s 0.83478 and the latter had deeper drawdowns as well. However, the Sortino Ratio tilts the scale towards Birla’s fund: 0.10762 vs. UTI’s 0.09043.

Conclusion

If you are looking for large-cap exposure then go for Birla Sun Life Top 100 Fund.

FundCompare: Pruning your Mutual Fund portfolio

The dilemma

Ownership of a diversified, un-correlated set of assets remains the touchstone of a well crafted portfolio. We had discussed how adding bonds to your equity portfolio reduces volatility before. However, comparing correlations between funds within the same asset class is a challenge.

For example, say you already have the Reliance Equity Opportunities Fund in your portfolio and your agent is pitching the Sundaram Select Midcap fund, how do you figure out whether to add to your existing holding of the Reliance fund, add an extra line item or switch to Sundaram?

Comparative returns

reliance_sund_returns

Between 2006-04-03 and 2014-12-19, Reliance’s Fund returned a cumulative 280.08% with an IRR of 16.55% vs. Sundaram’s cumulative return of 290.44% and an IRR of 16.91%.

As you can see, the wealth charts are almost on top of each other. The correlation chart confirms it:

reliance sund cor

Except for a few outliers, they are almost the same fund packaged differently.

Histogram of returns

The FundCompare tool also gives you the histogram of fund returns and the associated skewness. In this case, the Reliance Fund has a skew of -0.15 vs. Sundaram’s +0.22. Given that the average returns are more-or-less the same, this means that Sundaram’s Fund is better. Besides, it also appears that Sundaram’s Fund has a better Sharpe ratio.

Given that Reliance’s Fund has an expense ratio of 2.29% vs. Sundaram’s 2.26%, I would say “switch.”

Compare Your Funds

Before pulling the trigger based on what your fund broker/adviser tells you, get a free quantitative analysis of your options on our FundCompare tool.

Re-factored Indices and Momentum

We have created a whole bunch of Themes based on indices published by the NSE. We call them Re-factored Indices because they use a weighting that is different from NSE’s. We currently have free-float cap weighted and equal weighted themes. Investors can now invest in standard indices directly, without having to go through an index fund.

These Themes are automatically re-balanced once a month. There is no discretion on what goes into them, the portfolio is decided by the NSE/IISL. Investors can use these to “set it and forget it.”

Long-term out performance

Some indices show persistent long-term out-performance. For example, MNCs have beaten PSEs (StockViz) and have shown to have lower draw-downs. Investors can map the MNC Theme and let NSE/IISL figure out what stocks should be part of that index.

Momentum

Short-term investors can use momentum effects to their advantage and implement a switching strategy. For example, CNX BANK shows greater momentum than CNX ENERGY:

CNX BANK

CNX ENERGY

And over the last week, momentum in CNX REALTY has improved drastically whereas CNX IT has decreased:

CNX IT

CNX REALTY

Conclusion

Re-factored Indices can act as ETF-proxies for long-term, passive investors and opens up interesting momentum strategies for short-term investors.

India Hedge funds under-perform a simple Momentum strategy

Long/short equity funds, which make up a bulk of the India-specific funds, are up 47% year-to-date.

LiveMint recently ran an article, “India hedge funds outperform, but investors remain sceptical.” (link)

I don’t have access to the report quoted in the article and I am not sure if the returns are after fees and profit-sharing. But what is surprising is that these funds under-performed a basic, un-levered, momentum strategy. In the same period, our Momentum 200 Theme is up 61.54% and you can take all of it to the bank.

If you are charging 2 and 20, you should do better. Besides, most of them haven’t been through a down-cycle. And yes, Momentum will totally get crushed in a down-cycle, but at least investors know what they are getting into. For all you know, hedge funds, being the black-boxes that they are, could be just long momentum.

Turns out investor skepticism is warranted after all.

momentum.performance