Over 65% of diversified equity schemes underperform their benchmark indices

Mumbai, Aug. 30 Those who hold that three to five years is an apt period of time to judge mutual fund returns could do well to take a look at the three-year returns of Indian mutual fund schemes at this point in time. 

More than 65 per cent of the diversified equity schemes have underperformed their benchmark indices over the three years ended August 25, a compilation of annualised returns for the period by Value Research shows. 

Around 30 per cent of these schemes have recorded returns that exceed their benchmark indices. The data for the rest were not available. 

Benchmark track 

While the benchmark index of a scheme is a parameter against which fund houses measure the performance of their schemes, there is no mandate on the fund houses to deliver benchmark returns, said a mutual fund analyst. 

However, the benchmark is important as it helps you track the return of a fund, said Mr. Apoorva Shah, Fund Manager, DSP Merrill Lynch, most of whose equity diversified schemes have outperformed their indices for the period. 

“Also it should be a fund manager’s endeavour to beat the benchmark, otherwise the investor should put his money in benchmark stocks or an index fund, which will cost less too.”

According to analysts, one of the reasons for the schemes’ underperformance is that a major portion of their portfolios consists of mid-caps, which have suffered badly in the past year.

“The schemes do not have a hundred per cent linkage to their benchmark indices, which is one of the reasons they lag behind,” said Mr Vineet Potnis, Chief Marketing Officer, DBS Chola Mutual Fund, most of whose schemes have underperformed their indices. 

“The portfolios of the mid-cap funds had to be changed as the market cap of mid-cap stocks kept on changing, and that was one of the reasons we missed out on opportunities,” he added.

Among the fund houses that had several of their schemes underperforming their indices are Birla Sun Life Mutual Fund, UTI Mutual Fund, ING Mutual Fund, Tata Mutual Fund, DBS Chola Mutual Fund and Kotak Mutual Fund. 

The laggards 

Among the schemes that showed the widest margins of underperformance against their benchmarks were DBS Chola Global Advantage, JM Emerging Leaders, Franklin India Prima, Birla Sun Life Dividend Yield Plus, Birla Sun Life India Opportunities, Canara Robeco Emerging Equities, DBS Chola Multi Cap, Kotak MNC, LICMF Growth, Magnum Emerging Businesses, Principal Dividend Yield, Principal Junior Cap, Tata Midcap, Taurus Discovery Stock and UTI Mid Cap.

If the fund manager gets changed, then too the performance of the fund gets affected, said a fund manager with a top mutual fund house.

While in the US markets, the funds invest in “gigantic large caps” and it is difficult for them to outperform those stocks, in India there is scope for bettering the benchmark, provided the fund managers have the expertise, said another fund manager. 

“Ideally 3-5 years is the appropriate time period for a mutual fund investor to view the appreciation in his investments,” said Ms Mallika Baheti, mutual fund analyst, Sharekhan Ltd.

For the lay person, however, investing in mutual funds is still easier and simpler compared with investing directly in equity, she added.

Source: http://www.thehindubusinessline.com/2008/08/31/stories/2008083151260100.htm

Why hedge funds may be good for Indian markets

The Draft Report of the Committee on Financial Sector Reforms headed by Professor Raghuram Rajan was issued for comment in April 2008. Among the proposals that the high-level committee made was the introduction of domestic hedge funds. The committee feels that, “The presence of hedge funds would induce greater competitive pressure for other regulated fund management channels such as mutual funds.” 

This week’s article discusses the benefits of introducing hedge funds in the Indian market. It shows how hedge funds could improve asset price efficiency. Besides, such funds, by virtue of their diverse investment styles, could provide investors an opportunity to enhance their risk-adjusted portfolio returns. 

Of different genre 

Suppose a long-only (mutual fund) manager and a hedge fund manager both have a negative view on SBI, a positive view on HDFC Bank and a neutral view on ITC.

Long-only active managers will buy ITC in the same weight as their benchmark index, may overweight HDFC Bank and may not take any exposure in SBI. There is a reason for such a strategy. Active managers strive to beat their benchmark index. But they do not take too many active bets, lest their bets go wrong. Often, active funds tail the benchmark index with few active bets. Importantly, such managers cannot short-sell to take advantage of their negative view on a stock. 

Hedge fund managers’ do not suffer from such constraint. In the above example, the hedge fund manager may overweight HDFC Bank, short-sell SBI and not take any exposure in ITC. 

Better still, to neutralise any market risk, the hedge fund manager may buy HDFC Bank and short-sell SBI in such a way that the market risk in HDFC Bank is offset by short-selling SBI. Often, neutralising market risk on a portfolio would mean short-selling Nifty futures. 

Exploiting price inefficiency 

Hedge funds identify mispriced assets and exploit any price inefficiency. One way to do this is to employ statistical arbitrage.

Suppose a hedge fund manager finds that combination of one share of HDFC Bank and two short shares of SBI (1HDFC – 2SBI) has a stable statistical distribution. If the “spread” wanders far away from its mean, a hedge fund manager would set-up this strategy with a view that the “spread” will tighten. Such relative-value strategies can help arbitrate away asset price inefficiencies in a “normal” market. 

Besides, hedge funds employ strategies to arbitrage price differentials between the derivatives and the spot market. Suppose a stock is trading at Rs 1,480 in the spot market. Assume that the hedge fund manager, based on her proprietary model, believes that the futures price should be only Rs 1,470 against its current market price of Rs 1,510. 

The fund manager will short the futures contract and simultaneously buy the stock in the spot market. The trade will be profitable as long as difference between the spot price and the futures price is less than Rs 40. 

As more hedge funds exploit such price differentials, disconnect between the spot and derivative markets could gradually reduce. And that could attract long-term hedgers to the market. 

Higher risk-adjusted returns 

Hedge funds create value for investors through their diverse investment styles. Here are some examples.

Relative-value strategies such as fixed-income arbitrage and market-neutral style strive to back-out beta exposure and provide alpha returns. Such strategies typically carry lower volatility than government bonds but generate higher returns. They, hence, act as returns-enhancers when combined with a bond portfolio.

The long-short investment style (such as 130 per cent long position and 30 per cent short position in equity) is a high-risk high-return strategy. The volatility of this strategy is lower than that of the traditional equity strategy. This strategy, hence, acts as return-enhancers when combined with equity portfolios.

The managed-futures investment style primarily takes exposure in commodity futures. This style acts as a risk-diversifier for an equity portfolio.

Of course, there are risks with such investments. Hedge funds typically employ high leverage. This causes a systemic risk in the event a fund folds because of high drawdowns. Besides, monitoring such managers is important because many of them may charge alpha fees for beta exposure. 

It is not surprising that the committee has recommended that hedge fund investments be offered only to those who can invest Rs 1 and above. A similar such rule exists in the US.

Conclusion 

It is important to understand that arbitraging price inefficiencies does not mean that hedge funds will prevent formation of market crashes or asset price bubbles. Hedge fund managers can be as irrational as the professional long-only managers and investors. 

Yet, the introduction of hedge funds will be a welcome move to the Indian markets for two reasons — such funds can provide higher risk-adjusted returns for investors and can facilitate better asset price efficiency.

(The author is an investment strategist. He can be reached at enhancek@gmail.com)

Source:http://www.thehindubusinessline.com/iw/2008/08/31/stories/2008083150150800.htm

Going for FD? Check out FMPs first

Fixed maturity plans (FMPs) seem to have a lot going for them. Indicative yields have risen to as high as 11.5% of late, giving them a clear edge over fixed deposits (FDs) and drawing in ever more investors. By some estimates, almost Rs 1,00,000 crore has been invested in these schemes since the beginning of this year. 


Let's try to understand what makes these instruments so popular. 

What is an FMP? 

An FMP is a closed-ended mutual fund, which invests in debt securities. Thus, unlike open-ended mutual funds where an investor can enter and exit at will, one can invest in an FMP only during the new fund offer period. Every FMP has a certain maturity period, varying from a month to 3 years. Investors who want to exit before maturity typically need to pay an exit load of 2%. 


What kind of returns do FMPs give? 

FMP returns vary depending on the state of the debt market. If interest rates are on the higher side, then the returns offered by FMPs are also high. This is because FMPs invest in debt securities issued by corporates and if the interest rates offered on these securities are high, the FMP returns also go up. 


Currently, returns offered on FMPs of one-year maturity are between 10.5% and 11.5%. FMPs typically give out indicative yields to their distributors at the time of launch - this is the annualised return they hope to earn. 

How do FMPs indicate yields in advance? 

Mutual funds have a fair idea of the debt securities on offer and the interest rates going on them. They try and match the tenure of the debt securities chosen for investment by them with the period of maturity of the FMP. This way, they are able to lock in the return at the very beginning and thus calculate the indicative yield. 

Is higher indicative yield the only criterion for selecting an FMP? 

There is no simple answer to that as the yield has been projected on the assumption that every debt security the FMP invests in will pay up at the end of the tenure. In a bid to offer a higher indicative yield, some mutual funds end up investing in highly risky debt securities. Since the risk involved is higher, the interest offered on these FMPs is also higher, and so is the indicative yield. 

Investors should check up on the portfolio of investments planned by the FMP before taking the plunge. If it lists a lot of debt securities with ratings of less than AA, it is best to avoid investing. Remember, AAA is the highest rating. 

How is the tax calculated? 

Like other mutual funds, returns on FMPs are categorised as capital gains. 

If you invest in an FMP with a maturity of less than one year, the entire capital gain is lumped on to your income for the year and taxed according to the tax bracket you fall into. So, if you are in the top tax bracket of 33.99%, the short-term capital gain on an FMP will be taxed at that rate. 

For FMPs with maturity of one year or more, one needs to pay long-term capital gain tax, which is charged at 10% without indexation or 20% with indexation, whichever is lower. Say you invest Rs 50,000 in an FMP of one-year maturity at Rs 10 per unit and hence get 5,000 units. The indicative yield on the FMP is 11%. 

At the time of maturity, the FMP meets that yield and so at maturity, the net asset value of one unit stands at Rs 11.10 (Rs 10 + 11% of Rs 10), which takes the total value of 5,000 units to Rs 55,500 (5,000 x Rs 11.10). This means a long-term capital gain of Rs 5,500 (Rs 55,500 - Rs 50,000), on which tax at the rate of 10% works out to Rs 550. So, the net gain would be Rs 4,950 (Rs 5,500 - Rs 550). 

The indexation method takes into account inflation while calculating the purchasing price. For this, the government issues index numbers every year. These numbers are available in the instructions accompanying Indian Income Tax Return forms. 

Say the index number for the year in which the investment is made is 600 and the index number in which the investment matures is 650. One can divide 650 by 600 and multiply the resultant multiple (1.083) with the cost of purchasing the units (Rs 50,000) to arrive at the indexed cost (Rs 54,167). So the capital gain is Rs 833 (Rs 55,000 - Rs 54,167). 

Tax on Rs 833 at the rate of 20% works out to Rs 167, which is lower than Rs 550 arrived at by taking the 10% rate without indexation, and is the tax to be paid. The post-tax capital gain thus works out to Rs 5333 (Rs 5,500 - Rs 167), giving a post-tax yield of 10.67%. 

Are returns on FMPs higher than on FDs? 

The interest earned on a fixed deposit (FD) is lumped with the remaining income for the year and taxed according to the highest tax bracket the individual is in, irrespective of whether the FD has a maturity of less than one year or equal to or more than one year. Given this, FDs of one year or more give a much lower rate of return than FMPs. 


Take an FD, which matures in one year and gives an interest of 11% (similar to the indicative yield of the FMP). If the individual is in the top tax bracket, the post-tax return works out to 7.26% (11% - 33.99% of 11%). This is much lower than the indicative yield on the FMP. Even in the lowest tax bracket of 10.3%, the post-tax return of an FD stands at 9.86% (11% - 10.3% of 11%). 

Most one-year FDs offer much lower interest rates than the indicative yields on FMPs. But then, the returns on FMPs are at best indicative andnot guaranteed, which makes FDs a safer bet.

India Appoints D. Subbarao as Central Bank Governor

Sept. 1 (Bloomberg) -- India unexpectedly appointed Finance Secretary Duvvuri Subbarao as the next governor of the central bank, which is fighting the fastest inflation since 1992. 

Subbarao will serve for three years, replacing Yaga Venugopal Reddy whose term ends on Sept. 5, Finance Minister P. Chidambaram told reporters in New Delhi today. 

Eight of 10 economists surveyed by Bloomberg News expected the government to extend Reddy's term because of his decade-long experience at the Reserve Bank of India. 

Subbarao may have to follow Reddy's four-year-old policy of raising borrowing costs as inflation has shown few signs of easing. India's central bank, which prepares monetary policy in consultation with the finance ministry will pull out all stops to check prices ahead of elections due by May 2009. 

``Managing inflation, and simultaneously making sure growth isn't hindered, is going to be the biggest challenge,'' said Prasanna Patankar, chief bond trader at Securities Trading Corp. of India Ltd. in Mumbai, a primary dealer that underwrites government debt sales. ``The investor community is also expecting more stability in the immediate term.'' 

The Reserve Bank governor is appointed by the prime minister, based on the recommendations of the finance minister. Prime Minister Manmohan Singh, who headed the central bank in the early 1980s, pledged this month to bring price gains to a ``reasonable'' level. 

Raising Rates 

Reddy had raised the central bank's benchmark repurchase rate by 125 basis points to 9 percent since June, when the government increased fuel costs to lower its subsidy bill. The inflation rate jumped to more than 12 percent in the week of Aug. 9 from 8.75 percent before the fuel-price increase. 

Altogether, Reddy increased the repurchase rate by 300 basis points since October 2004 to prevent the second-fastest growing economy after China from overheating. He also raised the proportion of funds that lenders need to set aside as reserves by 400 basis points to 9 percent since December 2006 to check money supply from stoking inflation. 

To contact the reporters on this story: Cherian Thomas in New Delhi at cthomas1@bloomberg.net;