Most asset management companies usually publish monthly reports (also called fact sheets) that contain critical information related to the portfolios, at times a roundup on debt and equity markets from the fund manager and performance details of the schemes managed by the AMC.
The idea is to help investors (both existing and potential) to track the performance of the mutual fund schemes so as to take an informed decision. To that end, factsheets serve as an investor’s guide.
To be sure, factsheets were always meant to be the investor’s guide. However, in many cases, they are not upto the mark leaving much scope for improvement and even standardisation. We highlight the most critical reference points for the uninformed investor based on data that is more or less standardised across AMCs.
For ease of reference, we have divided the article in two parts, the first part discusses how to assess the equity fund factsheet and the second part discusses the debt fund factsheet.
A) Equity fund factsheets
Stock allocation
Thankfully, factsheets of most AMCs highlight the portfolio composition well enough, although there is scope for standardisation. For an investor who wants to invest in equity funds, the factsheet can offer some critical insight into the fund management style/approach.
To begin with, consider the top 10 stocks in the portfolio to determine the level of diversification. In our view, a diversified equity fund should have no more than 40 per cent of net assets in the top 10 stocks. This should help the fund negotiate volatility more effectively than its concentrated peers. For instance, Sundaram BNP Paribas Growth Fund is a fund we like for its disciplined investment approach (no more than 5 per cent of assets in a single stock) that ensures that its top 10 stocks are well-diversified.
Sometimes, a fund could be well-diversified across the top 10 stocks, but investments in a single stock could be so high so as to offset an otherwise diversified portfolio. A case in point is HDFC Capital Builder (a well-managed value fund), which was done in during the market crash in May last year due to unduly high investments in a single stock (Hindustan Zinc).
Also look at the fund’s portfolio over several months to get a sense of the consistency in the fund manager’s stock picks. Too much churn in the stock picks (new names every other month) indicates that the fund manager could be punting rather than investing, thereby adding to the trading cost, which ultimately eats into the returns.
Sectoral allocation
Just as you evaluate the stock allocation, it is important to consider the sectoral allocation of the equity fund. Diversified equity funds should be well-diversified across stocks and sectors. A fund could be well-diversified across stocks, but may pay the price for not diversifying well enough across sectors.
For instance, Sundaram Growth Fund, a fund we admire for superior diversification across stocks, learnt the hard way during the last market slide that diversification across stocks is as important as diversification across sectors. The fund had unduly high investments in infrastructure-related sectors.
The crash proved particularly harsh for the fund, as it had failed to diversify across other sectors. So like stocks, being diversified across sectors is just as important; unfortunately, it often takes a sharp dip in the stock markets to highlight the importance.
However, funds like HSBC Equity Fund, which pursue the top down investment approach, have concentrated sectoral allocations, which suit their investment style. These funds need to be evaluated differently from funds that pursue the bottom up investment style.
While calculating the sectoral allocation, the investor must combine like-natured sectors to understand the level of sectoral diversification. For instance, most equity funds list Auto and Ancillaries sectors distinctly; given the similar nature of these sectors, their allocation must be combined.
Another problem relates to the categorisation of companies across sectors. Different equity funds categorise the same company across different sectors. There is no standardisation. While AMFI (Association of Mutual Funds of India) has introduced certain standardisation processes in this regard, the same is not adhered to across the industry.
Asset allocation
Stocks and sectors apart, there is another detail that must catch your attention and that is the asset allocation. The asset allocation table tells you how the fund’s net assets are diversified across stocks, current assets/cash. An equity fund’s allocation to cash should be noted.
Among other reasons, this could be because the fund manager is not comfortable with market levels at that point in time. This fact can be established easily by browsing through the previous month’s factsheets. If the fund manager has been in cash for some time, it means he does not find enough stock-picking opportunities at existing levels.
Being in cash could work in the fund manager’s favour if the market crashes, like it did for Sundaram BNP Paribas Select Midcap May 2006. But a higher cash allocation works against the fund during a rising market, when being fully invested is what counts. Sundaram BNP Paribas Select Midcap has also witnessed this scenario, which explains its relative underperformance over the last few months.
Other data points
In addition to the points listed above, there are some data points that must be marked by the investor.
Portfolio Turnover Ratio
Put simply, this ratio tells the investor how much churn the portfolio has witnessed. This ratio is calculated based on the number of shares bought and sold by the equity fund over the review period. A high Turnover Ratio (vis-�-vis peers or other equity funds from the same fund house) indicates that the portfolio has seen above-average churn.
A high churn by itself does not necessarily imply that the fund is good or bad, however, it must be in line with the fund’s investment philosophy. A growth fund can have a high turnover ratio (although that’s not necessarily a good thing as it adds to the trading costs and therefore eats into your returns).
However, a value fund should typically have a lower churn as the fund manager would usually be investing in the stocks over the long term.
Important as it is, the Portfolio Turnover Ratio is yet to be given due importance by the fund houses (maybe they are afraid of ‘exposing’ their fund managers). How else, do you explain the fact that fund houses either don’t reveal the Portfolio Turnover Ratios or when they do reveal them, it is not standardised thereby robbing investors of the opportunity to compare them across fund houses.
Expense Ratio
This ratio underscores how expensive your equity fund really is. A high Expense Ratio (regulations cap this at 2.50% for equity and debt funds) indicates that your mutual fund investment is expensive. As per regulations, fund management expenses, which form the largest chunk of the expense ratio, must decline with a rise in Net Assets. So larger equity have more scope to reduce their Expense Ratios.
Again, fund houses are not very enthusiastic about sharing this important detail with investors. However, they do declare this ratio every 6 months, which is only because regulations demand that they do so.
Fund manager information
It always helps to know who is managing your fund. Not that we have any particular fund manager in mind, rather we recommend that investors do not get infatuated by any fund manager in particular and look for investment teams instead. Over the long-term, it pays to have your money managed by a group of fund managers, rather than one star fund manager, who could quit the fund house any time and take the performance with him.
So keep an eye on the fund manager details, typically, there should not be many external changes in the fund management team. When the same names manage your money, over a period of time there is stability in the fund management process. Thankfully for investors, majority of the fund houses do provide the fund manager details.
B) Debt Fund Factsheets
Like their equity fund counterparts, debt fund factsheets offer enough insight to the debt fund investor. For this, investors have to keep an eye on at least three aspects:
Average Maturity
For debt fund investors, this is perhaps the most significant detail to look out for in a debt fund factsheet. Since the Average Maturity of a portfolio for a particular month in isolation does not tell the investor much, he must go back several months to see how the Average Maturity of the portfolio has moved in order to understand the fund manager’s view on debt markets.
To give investors an idea - if the fund manager has been maintaining a higher Average Maturity for some time, it means that he expects interest rates to fall over time. On the other hand, if the Average Maturity of the portfolio is lower, it means that the fund manager is cautious about interest rates. Ideally, investors must read up on peer factsheets to understand the consensus on interest rates and if your fund manager has a differing view, you must try to understand why.
Credit Rating Profile
Debt funds invest in securities with varying credit ratings. In the Indian context, most debt funds do not take on undue credit risk - i.e. they invest primarily in securities that are highly rated. Investors should mark the credit rating profile of the debt fund. A large chunk in AAA/Sovereign paper (which is the highest rating) implies that the fund is taking lower credit risk. On the other hand, a higher allocation to AA+/AA paper underlines the fact that the fund manager is taking credit risk.
Asset Allocation
The idea is to help investors (both existing and potential) to track the performance of the mutual fund schemes so as to take an informed decision. To that end, factsheets serve as an investor’s guide.
To be sure, factsheets were always meant to be the investor’s guide. However, in many cases, they are not upto the mark leaving much scope for improvement and even standardisation. We highlight the most critical reference points for the uninformed investor based on data that is more or less standardised across AMCs.
For ease of reference, we have divided the article in two parts, the first part discusses how to assess the equity fund factsheet and the second part discusses the debt fund factsheet.
A) Equity fund factsheets
Stock allocation
Thankfully, factsheets of most AMCs highlight the portfolio composition well enough, although there is scope for standardisation. For an investor who wants to invest in equity funds, the factsheet can offer some critical insight into the fund management style/approach.
To begin with, consider the top 10 stocks in the portfolio to determine the level of diversification. In our view, a diversified equity fund should have no more than 40 per cent of net assets in the top 10 stocks. This should help the fund negotiate volatility more effectively than its concentrated peers. For instance, Sundaram BNP Paribas Growth Fund is a fund we like for its disciplined investment approach (no more than 5 per cent of assets in a single stock) that ensures that its top 10 stocks are well-diversified.
Sometimes, a fund could be well-diversified across the top 10 stocks, but investments in a single stock could be so high so as to offset an otherwise diversified portfolio. A case in point is HDFC Capital Builder (a well-managed value fund), which was done in during the market crash in May last year due to unduly high investments in a single stock (Hindustan Zinc).
Also look at the fund’s portfolio over several months to get a sense of the consistency in the fund manager’s stock picks. Too much churn in the stock picks (new names every other month) indicates that the fund manager could be punting rather than investing, thereby adding to the trading cost, which ultimately eats into the returns.
Sectoral allocation
Just as you evaluate the stock allocation, it is important to consider the sectoral allocation of the equity fund. Diversified equity funds should be well-diversified across stocks and sectors. A fund could be well-diversified across stocks, but may pay the price for not diversifying well enough across sectors.
For instance, Sundaram Growth Fund, a fund we admire for superior diversification across stocks, learnt the hard way during the last market slide that diversification across stocks is as important as diversification across sectors. The fund had unduly high investments in infrastructure-related sectors.
The crash proved particularly harsh for the fund, as it had failed to diversify across other sectors. So like stocks, being diversified across sectors is just as important; unfortunately, it often takes a sharp dip in the stock markets to highlight the importance.
However, funds like HSBC Equity Fund, which pursue the top down investment approach, have concentrated sectoral allocations, which suit their investment style. These funds need to be evaluated differently from funds that pursue the bottom up investment style.
While calculating the sectoral allocation, the investor must combine like-natured sectors to understand the level of sectoral diversification. For instance, most equity funds list Auto and Ancillaries sectors distinctly; given the similar nature of these sectors, their allocation must be combined.
Another problem relates to the categorisation of companies across sectors. Different equity funds categorise the same company across different sectors. There is no standardisation. While AMFI (Association of Mutual Funds of India) has introduced certain standardisation processes in this regard, the same is not adhered to across the industry.
Asset allocation
Stocks and sectors apart, there is another detail that must catch your attention and that is the asset allocation. The asset allocation table tells you how the fund’s net assets are diversified across stocks, current assets/cash. An equity fund’s allocation to cash should be noted.
Among other reasons, this could be because the fund manager is not comfortable with market levels at that point in time. This fact can be established easily by browsing through the previous month’s factsheets. If the fund manager has been in cash for some time, it means he does not find enough stock-picking opportunities at existing levels.
Being in cash could work in the fund manager’s favour if the market crashes, like it did for Sundaram BNP Paribas Select Midcap May 2006. But a higher cash allocation works against the fund during a rising market, when being fully invested is what counts. Sundaram BNP Paribas Select Midcap has also witnessed this scenario, which explains its relative underperformance over the last few months.
Other data points
In addition to the points listed above, there are some data points that must be marked by the investor.
Portfolio Turnover Ratio
Put simply, this ratio tells the investor how much churn the portfolio has witnessed. This ratio is calculated based on the number of shares bought and sold by the equity fund over the review period. A high Turnover Ratio (vis-�-vis peers or other equity funds from the same fund house) indicates that the portfolio has seen above-average churn.
A high churn by itself does not necessarily imply that the fund is good or bad, however, it must be in line with the fund’s investment philosophy. A growth fund can have a high turnover ratio (although that’s not necessarily a good thing as it adds to the trading costs and therefore eats into your returns).
However, a value fund should typically have a lower churn as the fund manager would usually be investing in the stocks over the long term.
Important as it is, the Portfolio Turnover Ratio is yet to be given due importance by the fund houses (maybe they are afraid of ‘exposing’ their fund managers). How else, do you explain the fact that fund houses either don’t reveal the Portfolio Turnover Ratios or when they do reveal them, it is not standardised thereby robbing investors of the opportunity to compare them across fund houses.
Expense Ratio
This ratio underscores how expensive your equity fund really is. A high Expense Ratio (regulations cap this at 2.50% for equity and debt funds) indicates that your mutual fund investment is expensive. As per regulations, fund management expenses, which form the largest chunk of the expense ratio, must decline with a rise in Net Assets. So larger equity have more scope to reduce their Expense Ratios.
Again, fund houses are not very enthusiastic about sharing this important detail with investors. However, they do declare this ratio every 6 months, which is only because regulations demand that they do so.
Fund manager information
It always helps to know who is managing your fund. Not that we have any particular fund manager in mind, rather we recommend that investors do not get infatuated by any fund manager in particular and look for investment teams instead. Over the long-term, it pays to have your money managed by a group of fund managers, rather than one star fund manager, who could quit the fund house any time and take the performance with him.
So keep an eye on the fund manager details, typically, there should not be many external changes in the fund management team. When the same names manage your money, over a period of time there is stability in the fund management process. Thankfully for investors, majority of the fund houses do provide the fund manager details.
B) Debt Fund Factsheets
Like their equity fund counterparts, debt fund factsheets offer enough insight to the debt fund investor. For this, investors have to keep an eye on at least three aspects:
Average Maturity
For debt fund investors, this is perhaps the most significant detail to look out for in a debt fund factsheet. Since the Average Maturity of a portfolio for a particular month in isolation does not tell the investor much, he must go back several months to see how the Average Maturity of the portfolio has moved in order to understand the fund manager’s view on debt markets.
To give investors an idea - if the fund manager has been maintaining a higher Average Maturity for some time, it means that he expects interest rates to fall over time. On the other hand, if the Average Maturity of the portfolio is lower, it means that the fund manager is cautious about interest rates. Ideally, investors must read up on peer factsheets to understand the consensus on interest rates and if your fund manager has a differing view, you must try to understand why.
Credit Rating Profile
Debt funds invest in securities with varying credit ratings. In the Indian context, most debt funds do not take on undue credit risk - i.e. they invest primarily in securities that are highly rated. Investors should mark the credit rating profile of the debt fund. A large chunk in AAA/Sovereign paper (which is the highest rating) implies that the fund is taking lower credit risk. On the other hand, a higher allocation to AA+/AA paper underlines the fact that the fund manager is taking credit risk.
Asset Allocation
Like with equity funds, debt fund investors must consider the asset allocation of the fund under review. This should help him understand the investment approach of the fund manager and the risk he is taking. Debt funds invest mainly in corporate bonds and government securities, both of which carry varying risk. Investors must make a note of the assets invested across both these segments.
Then there are floating rate funds that invest predominantly in floating rate paper; in practice however, many are predominantly invested in cash/current assets for lack of adequate floating rate instruments.
Likewise, monthly income plans invest a portion of assets in equities (the maximum limit on which is predetermined), investors must check the equity allocation over the last several months to understand the kind of risk the fund manager is taking (on the equity side) and whether he is adhering to the ceiling on equity investments.
Then there are floating rate funds that invest predominantly in floating rate paper; in practice however, many are predominantly invested in cash/current assets for lack of adequate floating rate instruments.
Likewise, monthly income plans invest a portion of assets in equities (the maximum limit on which is predetermined), investors must check the equity allocation over the last several months to understand the kind of risk the fund manager is taking (on the equity side) and whether he is adhering to the ceiling on equity investments.
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