Consistency in performance over a period of time is a crucial deciding factor when selecting mutual fund schemes, said Crisil's Piyush Gupta.
"One important things is to look at what has been the consistency of ranking over a period of time. So if there is a fund, which has been ranked, even two, but it continues to remain in the second cluster over a period of time, that sort of indicates the consistency of performance that the fund has generated," the expert said while referring to the Crisil Mutual Fund Ranking report for the March quarter.
The report ranks mutual fund schemes within categories in clusters of five based on a set of performance criteria.
In conversation with BQ Prime's Alex Mathew, Gupta noted that mutual funds in the flexi cap and mid cap categories have shown stability over the past few quarters. Unlike these two categories, performance of small cap funds has varied a lot over a period of time, he noted.
"Looking at the flexi cap category, if I were to look at the ranking trends that we have published over a period of time, there is a fair bit of stability that we see. When we look at the latest ranking vis-a-vis the earlier quarters, for instance, 16 funds out of 22 funds that have been ranked in this category have maintained the same rank in the last two trading quarters," Gupta said.
A similar stability in ranks can be seen in the mid-cap category as well, 19 out of 24 funds retaining their rank in the last two quarters, the expert noted. "And even over a one-year period, almost 40% of the funds have retained their ranks, compared to their one-year-back ranking," he said.
The highest number of changes in ranking have come from the small cap category, said Gupta.
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Small cap, mid cap and flexi cap funds can be a good mix for a portfolio, opines FinFix's Prableen Bajpai, especially for investors that intend to hold on to the investment for the long term.
"For mid-caps, I think there is little room now created for even passive strategies within mid-caps because there are funds which are not able to beat the index. So, I think midcap 150 index will also play a decent role for investors when I would say 15–20-year horizon somebody who's investing today. So that tendency to keep chasing the best performer is not there. So, you can always create a core with a passive strategy there and, add of course, a small cap," she said.
Investors holding a large cap fund need not add a flexi cap scheme as there tends to be overlapping or duplication of holdings, Bajpai said.
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Underperformance by a particular mutual fund scheme over five-six quarters should be a red flag for investor, said Bajpai.
Since ratings and rankings follow different methodologies and time periods, she suggests a few signs for investors to look out for. They should check the trailing returns in comparison to the category average and benchmark. Next, investors can look at rolling returns with two-year and three-year windows and compare them with peer schemes and the benchmark.
Investors should also check the fund house's investment philosophy and whether this matches their own expectations, Bajpai said.
Here Are The Edited Excerpts
Piyush, I will start with you very quickly, can you take us through the methodology that you follow in the making of this report?
Piyush Gupta: This is a quantitative assessment... It's a combination of performance assessment as well as how the portfolios are stacked up at a given point in time. The first step, of course, is shortlisting mutual funds.
There are two primary criteria: one is the fund needs to have a performance track record. When I look at equity fund, we look at at least three years of performance track record. Second is asset management and we have a load on top of the 10 crores the fund has to have before it becomes part of the actual universe.
In terms of parameters, multiple parameters or set of parameters or any of your performance-based parameters, which looks at return and volatility, we look at rolling return to measure the performance and volatility of the same returns is considered as part of the ranking.
On the portfolio-based parameters, we look at the extent of diversification of the funds, both at the company as well as sector level. We also look at the liquidity of the underlying portfolios, where we look at basically how many stocks the fund has and how does it compare with the trading volume of each of those stocks in the market. The rankings that we publish are on a scale of one to five, rank one being the highest and rank five being the lowest in the ranking scale.
Now, Prableen... would you like to also weigh in on how you approach ranking of mutual fund schemes when you go to a client? It's not just the performance of a mutual fund scheme, vis-a- vis, its peers, but it's also fitment of the right mutual fund scheme with the approach that an investor should have. So, what else qualitative and quantitative do you look at?
Prableen Bajpai: Absolutely. I think we do refer to reports, such as Crisil, then Morningstar is there, Value Research is there... and all of them have their own methodologies and a couple of factors there, the filters are actually overlapping as well because, of course, performance is one of the common things that you know, all these reports are analysed to ourselves within performance.
Crisil is looking at the mean returns and we prefer to look at rolling returns. But for that, the restriction is that you should have a longish time period and along with the rolling returns, I also like to take a look at the trailing as well as the calendar year returns because that enables us to understand why, in a particular year, the scheme is not performing.
For example, in one of the categories, which Crisil has given a fund did not perform in 2020 at all and 2021 onwards, it's picked up. So, looking at the calendar year returns also helps us decide. Along with that, I think once we mix, trailing calendar and rolling returns Sortino ratio, I think is one of the good measures to check the downside risk.
So, of course, volatility is there, and volatility is not always bad. So, upside volatility is fine. We try and concentrate on how much the downside volatility is. AUM, we look at more than 100 crores. Other than that, I think conversations with AMC is understanding their approach to investing is equally important and that is more of a subjective sort of filter which we apply, but I think that plays its own role.
Cumulated with all these different criteria that these reports and these platforms give us along with our little filters, we are able to derive a decent list of funds... it's like a bucket that you create, you can keep picking from that.
Piyush... Let's start with the flexi cap category and, understandably, this category gets a lot of focus because of its ability to manoeuvre based on market trends. It has the ability to focus on any category of market capitalisation based on where the fund manager sees value, if that is indeed the approach. I will come to you about the key trends that you pick up in the quarter gone by, what are your key findings?
Piyush Gupta: Looking at the flexi cap category, if I were to look at the ranking trends that we have published over a period of time, there is a fair bit of stability that we see. When we look at the latest ranking vis-a-vis the earlier quarters, for instance, 16 funds out of 22 funds that have been ranked in this category have maintained the same rank in the last two trading quarters.
Further, if I want to compare with the latest quarter ranking vis-a-vis say one year back in March 2022, eight of the 22 funds have got the same ranking. So, at the overall level, the rankings haven't changed much over the last few quarters. There are three funds where we have seen ranking changes of more than two notches. As I mentioned, we are ranking them on a scale of one to five.
So, for example, HDFC Flexi Cap, it was ranked number three last year in March 2022. In the last one year, it has gradually moved up to rank one. Then, the other one IDBI Flexi Cap and Axis Flexi Cap, we have seen a decline in the ranking. So, I think IDBI was ranked one last year. It has gradually gone down to two and now, it is ranked three. Axis Flexi Cap, again, used to be ranked three in the last one year. In the last couple of quarters, it continues to remain in rank five, which is the lowest in the entire ranking universe.
Prableen... what are your own readings in the flexi cap space? And eventually, I would also like to ask you about when you draw that line when you say that okay, this particular fund is not working for me? And what helps you make that decision?
Prableen Bajpai: So, within flexi cap, HDFC Flexi cap is topping, and performance definitely depends on the style of the fund. So, flexi cap, typically from HDFC, followed more of a value style and it was the second worst performer in calendar year 2020 with 7% returns and, at that time, the better funds were actually getting more than 30% returns. So, now '21 onwards, it's of course moved up in its ranking and in '22, it has been topping.
PPFAS was negative last year and it's back and PPFAS is not actually considered in the Crisil report because of its allegations outside India, but I think it's a good flexi cap and, of course, we included in our list.
Likewise, I feel some of the funds which are mentioned here—Kotak Flexi cap, UTI, even SBI—I think they have been pretty consistent performers. They may not be ranking in the number one or number two spots currently, but I think over a period of time, they have generated decent wealth and there are reasons why the performance is not there.
For example, Kotak is a huge AUM now. It's a growth style fund and, of course, it's been sluggish and its performance you know in the last one and a half years as we see. So, there are different aspects why funds don't perform and that is why when we are looking at portfolios for our clients.
I think that decisions are never made on a quarter, one or two-quarter basis. I feel that there is a need for churn if something is underperforming, it's category average as well as the benchmark over five to six quarters. I think that is definitely a red-flag and as a retail investor, this is something a person, even a do-it-yourself investor, can follow that please check what is the category average and the benchmark. And if you feel that there is consistent underperformance in the scheme, then a bit of deep dive is required to understand what is the reason. But I guess if we were told somebody in 2020 that please invest in HDFC Flexi Cap, probably they would have said that oh... its showing such bad returns, why should we invest?
So, I think there's seasonality in funds. We need to understand what the style of investment is and that is how a healthy portfolio is created with a mix of all these strategies.
Let's move to the mid-cap strategy next and I am actually quite curious about what Piyush's readings are from here?
Piyush Gupta: So the mid cap category, like we discussed earlier like flexi cap, had a bit of stability when it comes to ranking trend and like Prableen mentioned, we need to look at fund’s performance over a period of time. So... when you look at the rankings over a period of time, there is a stability in a particular cluster. That gives you a sense of how the performances are trending.
On a midcap front again, I will say at the overall level, there are not many changes in terms of ranking 19 out of 24 funds retained their rank. So, only five funds have seen a change of rank in the last two quarters. And even over a one-year period, almost 40% of the funds have retained their ranks, compared to their one-year-back ranking.
There are two new funds which have seen more than two notches' movements. One is the Motilal Oswal fund and second is the HDFC mid cap fund, both of them have seen an improvement in the ranking.
Motilal was ranked three last year in March 2022. It has come up in the rankings in the last one year and ranked number one in the latest quarter. HDFC, again, it was ranked fourth last year and it has seen improvement in the ranking. Now, it is ranked two and, again, factors that Prableen spoke about earlier in terms of value investing, some of the exposures in the banking sector and PSU. These, especially then with HDFC mid cap fund improving its performance and thereby improvement in the overall ranking.
One would argue that in the large-cap category now, there's a very strong case to choose passive because of the kind of underperformance of active. But here we have seen the opposite happening where you still see significant outperformance possible. So, what's your reading of mid cap space?
Prableen Bajpai: So, if we look at just the calendar year returns from 2014 to 2022 for the direct schemes, it's interesting that none of the toppers has ever topped again. So, 2014, I think it was some scheme by UTI, the next year, it was the other scheme. So, none has actually been able to reach the top slot in the next year.
It's a huge divergence and I will give you a non-finance example of this. As a planner and an advisor, what I would like is that okay, fine, maybe the kid is not topping every year, but the kid is in the top five in the class, you know as a parent, what you want. I think similar with your fund, you want more consistency. that it's fine, you will retain the rank in the top quartile.
I think that's good and currently, I think the top two rankings in the Crisil Report, Motilal and Quant fund have done exceptionally well across different categories of the different approach that they have. Motilal, as per our readings and the filters that we apply, I would not read it at the top slot. My personal choices here would be based on our criteria, are Kotak Emerging, PGIM, SBI, I would rate them above Motilal for simple reasons of consistency in returns.
Overall, it's a good way that every quarter you look at how the rankings change, but again, it is over a period of time because equity investing is for the longish time period. Your actual work can be proved during different market cycles on that you are looking at times when interest rates are going up, as well as coming down, different sort of market crisis as well as run in the markets. So over different time phases, I think the real test of these schemes, they're able to give that and I think then the decision made is much better.
Well, let's talk about the last category Piyush, what stands out on the small-cap side?
Piyush Gupta: So, in small cap, unlike flexi cap and mid cap, we have seen a higher number of changes in terms of the ranking... We're going to talk about the major changes. Tata Small cap have seen improvement in the ranking by two notches. It was ranked four last year... and it has improved to rank two. HDFC small cap, again, has seen an improvement just like mid cap... It has gone up from rank five to rank two over the last one-year period. Franklin small cap companies fund, again that's the fund which has seen improvement in the rankings from four to two. Besides this, Bank of India small cap fund has seen a decline in performance and which has got translated into decline in the ranking from one to two. Now it is ranked three.
In terms of the topline funds, Quant, again in this category, continues to rank one and it continues to remain rank one over the last one year.
Okay. Prableen, key thoughts on small cap and then I want to come back to you on another question with regard to construction of portfolio.
Prableen Bajpai: Quant actually has topped in the last three years. On even calendar year basis, it has been able to give good returns. Nippon is a huge fund in terms of AUM, but I think it is still a very good consistent performer. They really don't hold cash. They are holding large caps to manage that. They look at growth at a reasonable price. So, it's a good robust framework that they follow.
Within the category, I think HDFC small cap is another good fund wherein they are truly a small cap with 80 and 80% above allocation to small cap. I think SBI small cap has been a consistent performer. Franklin has been good. So, all of them, I think... has done well.
I couldn't have been good in terms of consistency and of course, they have their own periods where performance is not really showing. And that is why one has to stay put and stick to the conviction. At the same time, one should not ignore the underperformance as well. Consistent underperformance as well and one must know as to why you are sticking to a fund even in times when it's not performing. So, I think with that clarity, the doubt will never emerge, and one would not chase the best performing fund.
What is the role according to you of these categories of mutual funds schemes? If somebody has an allocation to their portfolio, they will be able to understand what role it's supposed to play and how you are supposed to decide where to place it in your portfolio?
Prableen Bajpai: All these three are part of your core portfolio, especially for investors who have a longish time horizon. Small cap, I will not include for somebody who's just looking to invest for five to seven years. I think seven plus more horizon is required for small caps. Mid-caps...act more like the protein in your diet, which can give the boost likewise for small caps. Flexi cap... I think you should also agree that the majority of them are more like large caps now with almost 70% above allocations towards large caps. So the tilt is towards large caps and that is why I think the performance differences also bear in within the large caps.
So, you have to be sure that if you have a large cap, there is probably no need to add the flexi cap now... because it would result in duplication or overlapping of a lot of holdings. So, but still, even as a beginner, if you have a longer time horizon, these three categories... are good enough to create a portfolio.
For mid-caps, I think there is little room now created for even passive strategies within mid-caps because there are funds which are not able to beat the index. So, I think midcap 150 index will also play a decent role for investors when I would say 15–20-year horizon somebody who's investing today. So that tendency to keep chasing the best performer is not there. So, you can always create a core with a passive strategy there and, add of course, a small cap.
But I would toss this to Piyush for closing comments because this is indeed his report that we are discussing. In your opinion, how should an investor view this? So, what would you say that an investor should gain from this reading from this ranking on a quarterly basis?
Piyush Gupta: I think one important things is to look at what has been the consistency of ranking over a period of time. So if there is a fund, which has been ranked, even two, but it continues to remain in the second cluster over a period of time, that sort of indicates the consistency of performance that the fund has generated.
Second is that if the fund comes up in the top rank, but doesn't sustain for a long period of time, it's also a reflection of the markets and the style that the fund managers. For example, Axis was the top of the charts even in the ranking. It fell down primarily because of the style and HDFC, which follows a typical value strategy, has come up in the ranking in a given period of time. So, the rankings need to be looked at along with how the markets are, where the markets are positioned and also, the consistency of performance that eventually gets reflected even in these rankings.
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