Tag: mutual funds

Mutual Fund Alpha Charts

shyam October 17, 2015 0

Charting Alpha

Most mutual fund investors chase recent performance. However, experience shows that alpha, or out-performance, is rarely sustained in the fund universe. To visualize how alpha fluctuates across different time-periods, we extended the relative strength spread notion of stocks to mutual funds. By normalizing performance across multiple funds vs. a single benchmark, the CNX 500 index, we can get a sense for how stable the alpha is.

Exhibits

Have a look at the RS-Spread chart of the HDFC Growth Fund:

Notice how 1-year alpha was below zero between Oct’2012 and May’2014 and is now back below zero again. This should indicate that whatever strategy the fund is employing is not that great in generating sustainable alpha. Now compare that to the Birla Sun Life Frontline Equity Fund:

Notice how the fund has managed to outperform over the last 5-years. Here’s the MNC fund’s RS-Spread chart:

The FundCompare Tool

We update these charts daily for more than 100 funds. You can access them through our FundCompare tool. If you have any questions, give us a call or Whatsapp us!

Categories Investing Insight, Your Money Tags mutual funds, quant

A quick note on bonds

shyam October 14, 2015October 14, 2015 0

We compared the total returns from the short-end of the curve to Nifty. Here’s what we found:

IRR over the last 10 years for bonds was 6.53%.
Biggest drawdown was -5.04%.
Only two years of negative correlation with NIFTY.

Annual returns:

Equity curve:

Drawdowns:

The right place for bonds in a portfolio is for regular income. From a returns perspective, you are better off investing in equities. Bonds are no less volatile when compared to the returns they give, and are mostly correlated with equity volatility.

Categories Investing Insight, Your Money Tags bonds, mutual funds

The Problem with Dynamic P/E Funds

shyam September 26, 2015 0

Executive Summary

Dynamic P/E funds use the market Price-to-Equity ratio to decide on allocation. If the P/E ratio is deemed too high, they allocate more to bonds or arbitrage strategies and if the P/E ratio is low, they allocate more towards equities. This logic sounds good on paper. However,

The market always appears expensive around turnarounds – investors miss out on the recovery trade.
The market always appears cheap during downturns – investors end up being long equities when bonds tend to outperform.
It doesn’t protect against volatility as a pure-play bond fund would (bad fit if you are risk-averse.)
It doesn’t give you the returns of a pure-play equity fund (bad fit if you are risk-seeking.)
Since it dampens volatility, it doesn’t make sense to dollar-cost-average (bad fit if your looking for an SIP.)

It is a solution looking for a problem.

Analysis

We thank Franklin Templeton for running the Dynamic PE Ratio Fund Of Funds to perform our analysis. This is probably the only fund where a true apples-to-apples comparison can be made between a pure-play equity fund, a pure-play bond fund and a dynamic PE fund.

The Dynamic PE fund invests x% in the Franklin India Short Term Income Plan and 100-x% in the Franklin India Bluechip Fund based on the P/E ratio. All we have to do is look at how a buy-and-hold strategy of the components compare to the Dynamic PE fund to gauge the effectiveness of the strategy.

Dynamic PE vs. pure-play Equity

Between 2007-01-02 and 2015-09-23, Franklin India Dynamic PE Ratio Fund of Funds-Growth’s IRR was 10.93% vs. Franklin India Bluechip Fund-Growth’s IRR of 11.53%

Similar returns. Lesser drawdowns. Lump-sum investors will probably be fine with these returns.

Dynamic PE vs. pure-play Bonds

First, let’s compare the Dynamic PE fund to the Short Term Income Plan.

Between 2007-01-02 and 2015-09-23, Dynamic PE Ratio had an IRR of 10.93% vs. Short-Term Income Plan’s IRR of 9.49%

For investors worried about drawdowns, just investing in the liquid fund would have given similar returns with a lot less risk. A 35% drawdown is a lot for a fund that gives bond-like returns.

A bond fund like the Birla Sun Life Dynamic Bond Fund, for example, had an IRR of 9.65% over the same time period

Conclusion

Using the P/E ratio for asset allocation is a bad idea. Investors would have experienced similar returns but with smaller drawdowns if they had invested in a regular bond fund instead.

Related: Dynamic PE Funds

Categories Investing Insight, Your Money Tags mutual funds

Dynamic PE Funds

shyam July 21, 2015 0

Dynamic allocation

Ideally, you should buy stocks of companies when they are undervalued and sell them when they are overvalued. But what if the entire market is overvalued? Does it still make sense to try and find “bargains?” When valuations revert to mean, all stocks get dragged down with the rest of the market. To avoid this scenario, there are some funds that use broad-market valuations to dictate total exposure to equities vs. bonds/arbitrage. If this strategy works correctly, then drawdowns should be lower and long-term returns should beat a buy-and-hold strategy.

Let us pick the most popular of these dynamic allocation funds – the Franklin India Dyn PE Ratio FoF – and see how it works in practice.

Franklin India Dynamic PE Ratio Fund of Funds

According to MorningStar, the Dynamic PE Fund holds ~50% of its corpus in Franklin India Bluechip Fund. Instead of comparing the Dynamic fund to an index, lets see how it compares if you just bought and held the underlying fund.

Between 2007-01-02 and 2015-07-20, Franklin India Dynamic PE Ratio Fund of Funds has returned an IRR of 11.44% vs. Franklin India Bluechip Fund’s IRR of 12.67%

The draw-downs have been lower, but the returns have tracked buy and hold.

The twist in this story is the tax angle. To be treated as an equity fund for tax purposes, at least 65% of the corpus should be in equities. The Dynamic PE fund ends up being treated as a debt fund – so you end up paying tax on capital gains. Whereas if you just B&H the underlying equity fund, you pay no tax if you hold it beyond a year.

The Principal SMART Equity Fund

One way that fund managers have tried to work around the tax angle is to invest in arbitrage strategies instead of debt. For example, if you look at Principal’s SMART Fund (SMART from Factsheet – June2015,) even though they have only 43% in equities, the fact that they have 35% in cash-future arbitrage makes the fund an equity fund for tax purposes.

Between 2011-01-03 and 2015-07-20, Franklin India’s Dynamic PE Ratio Fund has returned an IRR of 10.28% vs. Principal Smart Equity Fund’s IRR of 11.86%

The slightly better performance came at the cost of higher draw-downs:

Who should invest?

These funds are good if you are scared about draw-downs and want some reassurance that you will not be buying overvalued stocks. However, not buying overvalued stocks is something that should be expected of all fund managers, irrespective of what the fund is called.

We can argue that shallower draw-downs help investors stick to the investment plan. They are less likely to panic and exit at the bottom. However, this where a good financial adviser earns his keep – holding the investor’s hand during volatile markets and helping him stick to the plan.

This could be a good fit for someone who is nearing the end of their savings phase and want an investment with lesser potential draw-downs. However, the same can be achieved at the portfolio level with a pure equity and a pure bond/arbitrage fund.

This leads us to the conclusion that these funds are good if you have a trust deficit and information problem. i.e. you don’t trust that a long-only equity fund will retrace its draw-down, don’t trust your investment adviser to stick around when the market tanks and don’t have a good portfolio level view on how your investments are allocated.

Categories Investing Insight, Your Money Tags mutual funds

Relative Returns of Midcap Funds

shyam July 17, 2015 0

Relative Returns

We wanted to see how different mutual funds compared to the CNX MIDCAP index. We took the annual returns of a dozen funds and subtracted the annual returns of the CNX MIDCAP index. This gives us an idea of how well the fund was managed.

The above result is a bit surprising. Other than the ICICI Prudential Value Discovery Fund, no other fund consistently beat the CNX MIDCAP index. Of course, returns are only half the story, these numbers don’t tell us the risks that were taken to achieve them.

Besides, none of the top funds in a year hold that position over the next (see this.)

Categories Investing Insight, Your Money Tags mutual funds, returns