Some news from the world of sports disturbed me recently.
A super-talented left-hand batsman, Vinod Kambli once a star player in the Indian cricket squad, has now been struggling to make both ends meet.
He started his career in the early 90s and shot to fame in no time. But he lost track soon after and never made a comeback. He crumbled under the weight of his own success and popularity. He has been asking for work assignments to make his ends meet.
Fortunately, after making an emotional plea for work assignments, reportedly a businessman extended a helping hand very recently to Kambli offering him a job (with a monthly salary of Rs 1 lakh).
This instance has been a reminder that no matter how sound your finances are when you are earning unless you invest wisely, you can’t assume that you will be able to retire peacefully unless you have planned well. Your stars nor your stardom cannot help you always.
Similarly, when you approach mutual funds to build wealth and accomplish envisioned financial goals, you can’t solely depend on the top-rated funds.
Most individuals excessively search for ‘top-rated mutual funds’ or ‘best-rated mutual funds’ on Google but let me tell you it doesn’t automatically warrant any success.
Like sportspersons, even mutual fund schemes go through good and bad phases of performance. But only a few know how to bounce back and perform consistently in the long run.
If the star performance is one-off or occasional, a mutual fund scheme may disappoint you in future. Never forget this.
Further, it is not necessary that the top-rated mutual fund of the present times will continue to command the same 4-star or 5-star ratings in the future. So, being top-rated doesn’t mean that the fund will continue to be at the top always.
At PersonalFN, we analysed the Indian mutual fund industry’s data to examine how various schemes managed their Asset Under Management (AUM) while most are in the race of garnering AUM instead of being prudent asset managers.
We analysed about 200 unique diversified mutual fund schemes which collectively had an AUM of Rs 11 lakh crore by the end of July 2022. We haven’t considered Equity-Linked Savings Schemes (ELSS) and Aggressive Hybrid Funds for our analysis.
You will be surprised to know, that the top 20 schemes, based on the AUM, accounted for 46% of the total AUM of diversified equity funds. The performance of some of the star-rated funds of yesteryears amongst the largest 20 schemes has been languishing of late.
Table: Star-rated funds of the yesteryears, now lagging on performance
|Returns Absolute (%)
|CAGR Returns (%)
|Sundaram Mid Cap Fund
|Nippon India Vision Fund
|HSBC Flexi Cap Fund
|Tata Large Cap Fund
|Kotak Flexicap Fund
|HDFC Top 100 Fund
|Axis Focused 25 Fund
|JM Large Cap Fund
|DSP Top 100 Equity Fund
|LIC MF Flexi Cap Fund
|NIFTY 100 – TRI
|NIFTY 500 – TRI
|Nifty Midcap 150 – TRI
|Nifty Smallcap 250 – TRI
Data as of August 25, 2022
Direct Plan and Growth Option considered. The list of funds is not exhaustive, only indicative.
Past performance is not indicative of future returns.
(Source: ACE MF, PersonalFN Research)
Let’s take some examples.
Kotak Flexicap Fund, launched in September 2009 to generate long-term capital appreciation from a portfolio of equity and equity-related securities, generally focused on a few selected sectors.
Although the AUM of Kotak Flexicap Fund grew over the years, its stock universe narrowed. The fund failed to capitalise on some lucrative opportunities. For instance, it missed the rallies in mid-cap IT companies over the last two years. Thus, while the portfolio was held with conviction, it hasn’t been able to retain the top star rating it once commanded.
Similarly, Aditya Birla SL Frontline Equity Fund, a large-cap fund — launched in August 2020 — and managed to garner a large AUM (of over Rs 21,500 crore as per portfolio data as of July 31, 2022) has failed to deliver over the last 5 years and taken many of its stars away. Even though the fund refrained from excessive portfolio churning compared to its category average, it lacked the nimbleness. Moreover, investments in some of the recently listed platform companies, such as One 97 Communications Ltd. (Paytm), Zomato Ltd., and PB Fintech, have weighed on its performance.
Another large-cap Fund, HDFC Top 100 Fund — a star performer of the yesteryears — with an AUM of over Rs 21,500 crore as per portfolio data as of July 31, 2022, has lost much of its sheen. It has failed to maintain consistency and trailed many of its peers on all parameters.
Against that, take the example of UTI Flexi Cap Fund, launched in May 1992 with the objective of generating long-term capital appreciation by investing predominantly in equity and equity-related securities of companies across the market capitalization spectrum; has been one of the best and most consistent performers (across parameters) in the Flexi-cap funds‘ category, and today has an AUM of over Rs 25000 crore as per the portfolio data as of July 31, 2022.
So, the point is that only a few funds have displayed a consistent performance over the long run. The funds that were rated 5-star or 4-star at some point by popular rating agencies have eventually lost their sheen due to the drop in performance
When you look at mutual fund ratings available in the public domain, keep in mind that they are often assigned on returns rather than a bunch of other quantitative and qualitative parameters.
Moreover, you will be surprised to know that a top-rated scheme by one agency may not even figure among the top-10 schemes of another agency.
At times, the top-rated mutual funds by an agency are also sponsored advertisements that some fund houses/brokers pay to promote a particular scheme.
Hence, don’t solely bank on star-rated mutual funds. Maybe it could serve to be only as a starting point for scheme selection. Beyond that, to spot the future star performers you need to look at a host of quantitative and qualitative parameters.
At PersonalFN, here are Quantitative and Qualitative Parameters we carefully analyse…
Testing on Past Performance
While past performance is not indicative of how the fund will perform in the future, it is a useful tool to determine how consistently the scheme has performed. This must be compared with the benchmarks and peers to determine how well the scheme has performed on a relative basis.
Performance Across Market Cycles
In addition, assess how consistently the fund has performed across bear and bull market phases and relative to its benchmark and the category peers. What separates the men from the boys, is the ability to manage the downside risk during corrective and bear market phases. When the fund can arrest the downside risk better, usually it can maintain its high star ratings.
Assessing returns alone does not tell how much risk the fund has exposed you to. Hence, evaluate the risk-reward ratios such as Standard Deviation (which measures the risk), Sharpe Ratio (which measures the degree of risk a fund took to generate extra returns over risk-free instruments), Sortino Ratio (which measures the fund’s ability to limit the downside risk) and Treynor Ratio (measures the extra returns the fund manager has been able to generate over the risk-free rate for a given level of systemic risk, i.e. the beta) over a 3-year period. This would give you a fair idea about the risk-adjusted returns of funds.
It is the portfolio characteristics and quality that determine how a mutual fund scheme would perform in the future. Hence, understand how the scheme is allocating its assets (as per its investment mandate) and the companies or securities it is exposed to.
Further, assess how well-diversified the portfolio is, and in this regard look at the top-10 holdings and top 5 sectors. If the top-10 stock comprises more than 50% of the fund’s portfolio, it means there is a portfolio concentration risk involved. At PersonalFN we believe, the scheme should not hold a highly concentrated portfolio.
Moreover, ideally, the fund manager should not be engaging in high churning (indicated by the portfolio turnover ratio). More churning means more expenses and may not necessarily result in higher returns. If a fund ends up exiting good stocks too early, the return potential may be lost.
Nevertheless, portfolio churning should be in context with the type of scheme, its investment objective, market conditions, macroeconomic outlook, and investment philosophy of the fund house. Usually, funds with a growth-oriented approach have high churning than those pursuing a value style. Similarly, the churning may be high during intense market volatility compared to when the markets are flat or in an upward trend.
In the case of hybrid and debt funds, you also need to evaluate the quality of debt papers held. Avoid funds with exposure to low-rated or unrated debt papers where the fund manager is engaging in yield-hunting. In such cases most often there is a high credit risk involved. Also considering the interest rate cycle, check if the debt papers are of the ultra-short, short, medium, or long maturity profiles.
Testing on Quality of Fund Management
A mutual fund house is in the business of managing the hard-earned money you invest in its respective schemes. Hence, it is important to judge if it is a ‘prudent asset manager’ or a mere ‘asset gatherer’. Hence avoid simply investing looking at the AUM, instead evaluate the following….
The efficiency of the fund house in managing your money: This can be weighed by checking the proportion of the AUM performing. Thus assess the number of schemes across respective categories that are worth your hard money. Keep in mind that a fund with a high AUM does not necessarily translate into better returns.
The credentials of the fund manager: The performance of a mutual fund is directly dependent on the ability of its fund manager to timely identify various opportunities available in the market. This makes it crucial to check the qualification and experience of the fund manager and the track record of the schemes he/she manages.
Funds-to-Fund Manager Ratio: This refers to the number of schemes managed by a fund manager. Ideally, we believe, a single fund manager should not manage more than 5 funds. If the number of funds managed by a single fund manager exceeds 5, we could consider him/her to be overburdened and that may impact the overall performance of the fund.
Apart from the above, it serves well to understand the overall investment processes, systems and risk management measures at the fund house. Always give higher importance to fund houses that follow sound risk management techniques and have robust investment systems and processes in place. This is because, usually, schemes that follow prudent investment practices can be expected to form consistently well over the long run than those investing as per the whims and fancies of fund managers.
At PersonalFN we diligently follow these comprehensive quantitative and qualitative parameters to recommend the best mutual fund scheme to our valued subscribers. We have deployed a S.M.A.R.T Score Matrix for this purpose:
- S – Systems and Processes
- M – Market Cycle Performance
- A – Asset Management Style
- R – Risk-Reward Ratios
- T – Performance Track Record
If you want to understand more about PersonalFN’s S.M.AR.T score matrix to pick the best mutual funds, watch this video by my colleague, Vivek Chaurasia, the Head of Mutual Fund Research.
In addition, to make a suitable choice, consider your personal risk profile, broader investment objectives, the financial goals you wish to address, and the time in hand to achieve those envisioned financial goals.
The next time you look at star ratings that are derived merely based on past returns, also evaluate whether those ratings capture a holistic picture.
This article first appeared on PersonalFN here