Mutual funds may have emerged as everyone's favourite investment avenue, but the tech stock tumble has taken its toll on most funds.

By A BT-Mutualfundsindia.com study

It's like a report card that you wish your parents never get to see. If they could forget about the year 2000, and simply wipe it out of their memory, droves of fund managers would love to do that. Out of the 158 equity-based mutual fund schemes we reviewed, just 15 ended the year with positive returns. If you put your money into the rest you'd have ended up losing money. But then Y2K was the year of turbulence in the equity markets. The BSE Sensex plummeted by 20.17 per cent, mainly because of the now well-documented tech stock blow-out that spread across the world, swinging out from the NASDAQ in the US to the JASDAQ in Japan.

With equity markets in a tailspin, mutual funds, especially the equity funds, fared no better. The infotech bug ate into the returns of almost all equity funds and their managers were left clueless about what to do with these holdings. Those that did perform in the last quarter of 2000, did so because their market values fell less than other funds. Says Vibhav Kapur, CEO, IL&FS Mutual Fund: ''Wherever the funds had higher exposure to ice stocks, their market values have dropped drastically.''

The tech stock bust was compensated to some extent by better performance of old economy stocks and this helped buoy some funds. Funds that had significant exposure to petrochemicals, FMCG, and pharmaceuticals could manage to offset the effects of the tech slump with the gains that these stocks garnered. The petrochemicals sector, in particular, put in a good performance and specialised funds like the UTI Petro managed to stay in the black, gaining nearly 30 per cent during the year.

Those specialising in the pharmaceuticals sector weren't as lucky. With only select pharma scrips gaining in the latter half of the year, pharma funds ended the year with their values getting eroded, some of them losing as much as 25 per cent of their values. Not many equity funds managed to outperform the market in the last quarter, as well as in the entire year. Indeed, in the last nine months, the first quarter's gains disappeared in the bear wave.

Even the debt market saw some volatility as the RBI increased interest rates, but the year ended with stable returns from debt funds. In the debt market, schemes gained importance as a safe investment option vis-à-vis other fixed income securities, particularly bank FDs. In an era when the average return from three-year deposits in banks is about 9.7 per cent, open-ended debt funds have posted much better returns with similar levels of risk and comparable liquidity.

A Volatile Year

Despite the volatile year, it's clear that the mutual funds industry has evolved and is now approaching maturity. The year began with inflows breaking records. UTI gained Rs 9,340 crore in the first quarter and was followed by private sector funds that mobilised around Rs 1,853 crore. Assets under management of the entire industry crossed Rs 100,000 crore, a landmark. Of course the growth was driven by the tech stock frenzy of the first quarter.

Equity funds mobilised the highest amount, accounting for nearly 90 per cent of the gross mobilisation in the first quarter. The second quarter began with signs of a slowdown. The Sensex slumped from above 6,000 points in February to touch 3,900 in May and this significantly eroded the wealth created in first quarter. Equity funds lost money with the steep fall in valuations of stocks and with the FIIs making a slow exit, the industry finished with lower assets under management.

UTI lost about Rs 271 crore followed by private sector mutual funds, which saw their values erode by Rs 313 crore. But the biggest losers were the public sector funds, which lost Rs 1,861 crore in the second quarter. The third quarter was even worse with equity fund assets losing nearly 24 per cent.

With RBI announcing a hike in interest rates, the NAVs of debt funds fell to adjust for it. This being a rare phenomenon, ordinary investors were aghast, as they had never expected it. The last quarter, however, brought with it hope, as the markets anticipated good results from corporate houses and gained. Still, in December, markets fell again eroding the gains notched up since October. The market fell by almost 2 per cent in the last quarter but surprisingly assets under equity funds gained 1.8 per cent during the period. This was largely due to fresh inflows in the funds.

ICE on the tracks

Fund managers' predilection in the first quarter for ice stocks was perhaps the single biggest reason for the poor returns turned in by equity funds. Yet, their current low valuations may make them attractive and, therefore, power another round of rallies in their prices. Although others seem to have cried off these stocks, the mutual funds have been rather exuberant in their ice stock picking. Funds like ING Growth, IL&FS Growth and Value, Alliance Equity and LIC Dhansamridhi, ETC, continue to be skewed towards the ice sectors. Says Nikhil Johri, CEO, Alliance Capital Asset Management: ''The weightage for ice stocks in the benchmark index-BSE 200-is about 32 per cent and relative to the benchmark the allocation to ice sector is not very high." Funds like Birla Advantage and SBI Magnum Multiplier, which were also skewed to ice in the earlier quarters are no longer skewed. Yet they continue to be fairly aggressive in ice sector and hold substantial investments to the sectors. Adds Kapur of IL&FS MF: ''We believe that in the medium term ice stocks will perform.''

On another front, leviathan UTI lost marketshare by around 1.43 per cent in the year, while the biggest losers were the bank sponsored funds, a pointer to the fact that performance of funds and services provided by AMCs do matter. The clear gainers in 2000 were the private sector Indian funds, the institutions and the joint ventures in the industry. Says M.R. Murli, CEO, LIC MF, which is in the process of setting up service centres: ''We have to get closer to the investor by offering better service and connectivity.''

Quarterly Blues

The last quarter was no different from the third quarter in terms of returns. Most equity funds lost the steam that had started building up again in November and ended with low returns. But the fall wasn't led by tech stocks alone. While select scrips continued to buck the trend, the market in general moved southwards in December. Among open-ended funds, sectoral funds that focused on pharma and petro sectors did well, with UTI Pharma Fund topping the list. Its investments in top-drawer pharma stocks like Ranbaxy, Cipla, Pfizer, and Wockhardt helped.

The close-ended equity funds' list of toppers includes some less renowned names. The quarter saw reputed funds like KP Taxshield, Birla Taxplan 98, and First India Taxgain lose value. Among these, KP Taxshield 98 had been among the best performers of the previous quarter. The gainers have some surprise entries in Ind Tax Shield and Ind Shelter. While Ind Sagar had been among the best in the previous quarter, the other two are new entrants. Taurus Libra Taxshield has not just improved its return in this quarter, but is the top performer of the quarter. The fund has gained on account of its low exposure to volatile sectors and big exposure to individual scrips like Flex Industries.

The balanced funds did not suffer as much as the equity funds. And that's been especially true of funds that had relatively low exposures to equity. The top fund in this category was the Zurich India Prudence Fund, which was helped by a highly diversified portfolio that is spread across several sectors, including petrochemicals, tobacco, and finance. Another boon: its exposure to ice has been low.

Among debt funds, the Chola Triple Ace topped with a return of 7.57 percent for the quarter. The fund has a good mix of corporate papers and an excellent rating profile with 98.08 per cent of its investments being in AAA rated securities. The average maturity profile of the fund is 2.6 years and it will gain in the event of some softening of interest rates. PNB Debt Fund was a consistent performer, its AMC drawing on its expertise in treasury management.

Trend Analysis

Our performance trend analysis evaluates mutual fund schemes on the basis of their risk-adjusted performance, taking the security market line as the benchmark. For equity and balanced funds, portfolio performance has been decomposed into premium for diversifiable risk to which the portfolio is exposed, while for debt funds, pure risk adjusted return has been taken as the measure for performance.

A total of 245 schemes were considered for the period ending December 31, 2000, which excluded funds with a life of less than one year. Certain schemes that do not disclose the NAVs more frequently have been dropped from the study. The performance was better this quarter as 67.75 per cent of the total schemes considered posted satisfactory returns viewed in the scope of the macro and micro factors governing the market. The same figure for last quarter was 52 per cent. While analysing the performances of the funds against the risk premium they generated for the investors by plotting the returns against risk free instruments, we find that only 8 out of 145 equity schemes were able to compensate the investors with adequate risk premium. The list has equal participation from public sector and private sector funds having four sector specific schemes and four tax saving schemes.

Among the best performers were open-ended sector schemes and tax saving schemes. Tax planning funds, with all 11 schemes in the open-ended tax saving category posting a satisfactory performance. A total of 27 out of the 49 close-ended tax saving scheme performed well. Out of 76 all-category tax saving funds studied, 42 funds were able to outperform their expected levels. The best fund on the basis of risk adjusted return is UTI Growth Sector Fund Services, which has, apart from ice, invested in sectors like banking, finance, hotels, hospitals, etc.

The runner up on the list is SBI Magnum Sector Umbrella Infotech, which, despite posting negative returns in the last quarter, has proved its superior stock selection ability in the sector and performed well in the preview of the market trends. It has posted an annualised return of 33 per cent since its inception in July 1999. It has top-rung technology stocks in its portfolio and it has the potential to post very good returns.

Both open-ended equity and open-ended debt funds performed well with 72 per cent of the schemes in each category posting satisfactory returns. Among balanced fund schemes, 64.75 per cent posted satisfactory returns. This is a marked improvement over the previous quarter when only 52 per cent of open-end equity funds (excluding tax planning schemes), 39 per cent of the balanced funds, and 70 per cent of the debt funds were able to perform well.

Although some top performers have not posted high returns in terms of absolute appreciation in NAVs in the last quarter of 2000, funds should not be judged on the basis of short-term returns. Investors ought to take a long-term view instead of looking for quick gains. The performance of tax planning funds, where investors keep their money for at least three years demonstrates that. Says Johri of Alliance Capital AM: ''To get the best out of equity funds you have to be a medium- to long-term investor.'' After all, mutual funds may be investment vehicles but they certainly aren't speculative instruments.

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