For several quarters in a row now, debt funds have been saving the day for fund managers. Equity has been bashed. But is it down and out? When the gloom lifts, stocks could make a stunning recovery. And you had better catch the market now.

By BT-mutualfundsindia.com Survey

Look at it whichever way you want, the quarter that ended September 30, is this fiscal's most happening yet. It opened with the infamous us-64 incident and, towards the end, closed with the attacks on New York's World Trade Center. An industry that was beginning to get a knot in its stomach over decelerating growth, had a nervous breakdown post-Tuesday Terror (as the day of the attacks has come to be called). In just a few trading sessions after the attacks, billions of dollars of investor wealth vapourised on the New York Stock Exchange, the NASDAQ, and the Bombay Stock Exchange, which lost 17 per cent rapidly and sent the Sensex spiralling to an eight-year low. The result: equity funds that in any case were struggling to keep their head above water, drowned.

The mutual funds report card for the quarter, then, throws up no surprises. So, what we decided to do was not just tell you how the funds performed, but also examine some big shifts that have happened in investing. In other words, we hope to give you a good peep inside the head of a fund manager. So, let's get this out of the way quickly: as in the past several quarters, equity trailed debt in both performance and mobilisation of funds. Now, for the bit we think is really juicy. After selling relentlessly during the whole of 2000-01, mutual funds finally turned net buyers in the market. In September, they bought Rs 111 crore worth of stocks more than what they sold. Fine, in a market where trades run into thousands of crores, that's chump change. But, folks, could this be the beginning of a revival in equities?

Agreed, it's premature to say anything for sure, but with indices at historical lows and valuations scraping the bottom, the time is as good as any to go bargain hunting. In fact, the winning fund managers of the next quarter-or the one after that-would come riding on the back of such a move.

This could be true for another reason. Most analysts feel that the next bull run may not be as blind as the one we just came off and, therefore, not everyone will make money on it. Also, after a long time, mutual funds sold debt on a net basis. For instance, they made purchases worth Rs 1,620 crore and offloaded debt worth Rs 1,871 crore. This, coupled with the trend of fund managers opting for short-term maturity debt rather than long-term debt suggests that they don't expect interest rates to drop any further.

One way or another, the days ahead are going to be difficult for portfolio managers. In anticipation of an upturn in stocks, they must park funds in short-term instruments. But that would mean lower risk and, hence, a lower rate of return. So, what should small investors, who do not have the time or the inclination to monitor fluid stockmarkets, do? BT suggests that they stay invested in funds of their choice (See Funds To Your Taste) for a long term. Time and again, experience has proved that short-term factors (like the attacks) should not guide long-term investment decisions. The chances of losing with such a strategy are very low.

Debt's The Best

Debt, debt, and more debt. That has been the story of mutual funds this year. Yet, the juggernaut seems to be slowing a bit, thanks to the uncertainty ahead. Returns this quarter were also low, compared to the previous three months. The highest that any income fund returned in q2 was 3.91 per cent (Escorts Income Plan-Growth), while the average was 2.09 per cent. That makes the previous quarter's 6.81 per cent top return look like a dream. What did Escorts Income do right? The fund, which as on September 30, 2001, had a corpus of Rs 18.38 crore, has invested mainly in the debt papers of state governments and their agencies, with some investments in bonds of financial institutions such as the IDBI and the IFCI. It has taken care to invest in 'A'-rated papers, which provide higher rates of return to compensate for higher risks of default.

Following the trend of the past few quarters, no debt fund posted negative returns in q2. The worst performers are actually those that have not fared as well as the toppers because of their exposure in equity, albeit very small. Alliance MIP and Templeton MIP were the worst performers, managing just 0.66 per cent and 0.71 return respectively. The culprit? Their exposure to equity. Templeton, for instance, had almost 8 per cent of its investments in equity as on September 28, 2001.

Dundee Liquidity Fund-366 Days was the top short-term (read: liquid and money market) fund for the quarter, with a 2.59 per cent return. Dundee has invested in bonds of public sector enterprises and financial institutions. It also has a high exposure-23.6 per cent-to call market, and has an average life of five months, comparable with most other funds in this category.

Again, all short-term funds performed reasonably well. The worst performer in this category was IDBI-Principal Cash Management Fund MCO-Growth, which returned just 1.63 per cent. The fund had a maturity of seven days as on September 28, and had invested in floating rate bonds of companies such as Exide, L&T, IL&Fs, ITC, and Nirma.

"EQUITIES LOOK VERY ATTRACTIVE NOW" Rajat Jain, IDBI Principal MF

At this point in time the markets are looking very attractive. It is because of lack of other alternatives, cheaper valuations, bottoming out of the economy and corrections in expectations. By that I mean people don't expect super-normal returns from the markets anymore. They expect reasonable returns, which in all probability should happen within a year's time. We expect Sensex to move up by at least 15 per cent within the next one year. We expect equities to outperform the debt avenues available at this point in time. There would be some amount of volatility in the market, but it would be a safe place to put one's money in now. The portfolio mix is of course subject to one's age and risk profile. But if a person is young-in the twenties and thirties-there is absolutely no harm in parking at least a part of the funds in equities, either directly or through mutual funds. Equities look to be the best investment avenue now. Just like people buy household goods and consumer durables during discount sales, they should buy stocks now. There is a huge discount at which some good stocks are going. Why buy them six months later at 40 per cent premium? As told to Shilpa Nayak

"THE STOCKMARKET IS UNDERVALUED" K.N. Siva Subramanium Vice President (Investments) & Fund Manager, Pioneer ITI

We expect the markets to improve over the next one year. Market have bottomed out around 2,600 levels a week or so back. The key indicators are in favour of the markets now. The market capitalisation as a percentage of the GDP is 20 per cent, close to an all-time low. The normal average figure is twice that. The yield of the Sensex companies is better than that of the 10-year debt benchmark. All in all, equities as a class are grossly undervalued at this point in time and small investors should make the most of it. While the economy still seems week due to the performance of some companies not being up to the mark, a bearish market mood is the best time to buy stocks. The macro indicators indicate undervaluation. Although there may be hits in the short term due to poor results by companies in the next two quarters, there should be a 20 per cent appreciation in the Sensex a year from now. We advocate equities to small investors after understanding their risk appetite, goals, and age. If age is on one's side, equities are the best bet, either through mutual funds or on one's own if one understands the market and has the time to track it. For passive investors, index funds are always there. As told to Shilpa Nayak

G(u)ilt Free

In absolute terms, Gilt was ahead of the other categories past quarter too. The top performer here was Chola Gilt Investment-Growth, with a 5.92 per cent return. The portfolio of the fund has seen a hike in its maturity profile between July and August, indicating that its managers expect further reduction in market yields. It has decreased exposure in cash and call at 4.7 per cent, while investing the rest in government securities. The average return posted by all gilt funds (growth option) was 3.56 per cent, and the lowest was 1.38 per cent (Zurich India Sovereign Gilt Saving-Growth).

All open-end balanced funds dropped into the negative territory past quarter, with the best performer (JM Balanced) managing to contain the fall at a negative 0.29 per cent. Apparently, what cushioned the impact in the case of JM was its well-balanced portfolio, where only 44 per cent is earmarked for equity and of the rest 37 per cent is in debt and 18.7 per cent in money market instruments. Further, its equity exposure is in reliable old-economy stocks such as Tata Steel, Reliance Industries, Reliance Petroleum, Brihanmumbai Suburban Electricity Supply (BSES), and Grasim.

If there's any fund that has done an egregious encore, it is Pioneer ITI Vista Fund-Growth. It has retained its position of the worst-performing balanced fund. Given that the fund is very inconsistent in publishing its portfolio, the exact source of its weakness could not be determined. We reckon it was its exposure to equity that did it in. Alliance 95 was the next worst with a negative return of 13.76 per cent.

Given the carnage in stockmarkets, it is hard to imagine that an equity fund-sector specific, to boot-could have emerged not just unscathed but with a profit. SBI Magnum Sector Umbrella-Pharma did just that with a 1.66 per cent gain.

The fund has holdings in some of the best pharma stocks. It has booked profits in Dr Reddy's and has lowered holdings in Cipla and Hoechst, while increasing exposure to Sun Pharma. As on September 28, 2001, it had 36.66 per cent cash, compared to under 8 per cent in July.

The second-best performer in the category, Pioneer ITI Pharma Fund, although its returns were negative, reshuffled its portfolio. The fund increased exposure in Aventis Pharma, Cipla and Ranbaxy in a big way, but lowered exposure to Dr Reddy's from 11.84 per cent in July to 7.27 per cent in September.

Among the losers in Sector funds category, technology funds were the hardest hit. Bleeding the most is Pioneer ITI Infotech Fund-Growth, which lost 40 per cent in the quarter. An exceptionally concentrated portfolio seems to the root of its problem. The fund's top four holdings-Infosys, Satyam, HCL Technologies, and Hughes Software-account for more than 55 per cent of the total assets under its management. Alliance Millennium lost a shade less-still a staggering 39 per cent-for the same reason: it's a tech fund.

Tax-saving schemes are significant because they provide tax relief to their investors and act as an incentive for investing in equity. By taking long-term calls on stocks they can bear short-term volatility in prices with relative ease, as investors are generally not allowed to redeem money before three years. As a result of this, most equity-linked savings scheme (ELSS) would perform well on a longer duration, even if they have a bad record in the short-term.

That, in short, is the story of tax saving schemes past quarter. All such funds made losses, with Canequity being the worst performer and Dundee Taxsaver Fund topping the charts, in the sense that it only lost 1.62 per cent, compared to Canequity's 27 per cent. Dundee has benefited from its diversity of investments spanning pharma, petroleum, food, and other infrastructure sectors. Canequity, on the other hand, has a huge 31 per cent invested in Infosys alone. The loss on this counter was enough to wipe out gains made by all the others stocks in its portfolio.

The Risk-Return Equation

To understand the performance of funds on the risk-return framework (that is, how much return the funds earned relative to the risk profile of their portfolio), BT-mutualfundsindia.com studied the performance of open-ended funds (only growth options) over a period of three years ending September 30, 2001. Funds with life less than one year, and those that have been inconsistent in declaring their NAVs have been excluded.

The top debt performer last quarter, we discovered, was Reliance MIP. The fund has a decent portfolio with predominant investments across debt and with a minuscule portion of equity as well. It has some decent papers, too, including bonds of SBI and Rural Electrification Board. Overall, the investment quality is good, with the exception of Ballarpur Industries, whose paper, despite its d1+ rating, has found its way into the portfolio of the scheme.

The equity portion of the fund comprises relative non-movers in Chambal Fertilizers, Tata Chemicals, and GE Shipping. It had an average maturity of almost two years as on August 31, 2001. Number two in this category is Escorts Income Fund, which is among the two that have retained their places in the top five funds from the list last time (the other is Chola Freedom Income). The fund has exposure to bonds of several agencies of state governments, and that imparts it some security against credit risk. It also has investments in papers of IDBI and the IFCI.

The top equity performer on the risk-adjusted scale was the UTI Growth Sector Fund-Services. The fund has also been the top sector fund for the period of study, which included the performance of growth options of all open-ended equity funds with a life of more than one year over a period of three ending September 30, 2001. The reason for its good performance is its diversity of portfolio. As per the latest portfolio information released on June 29, 2001, the fund had invested heavily in old economy with only three ice scrips-Infosys, VSNL, and Sterlite Optics-among its top 10.

Among the open-end diversified funds, Tata Pure Equity Fund has been the top performer on the risk-return framework. The fund, an average performer in terms of its historical returns, has opted to stay put in stocks such as SBI, L&T, Bajaj Auto, Ashok Leyland, and Nestlé, all of which are steady stocks. It has managed to stay ahead of its more fancied peers by sheer conservatism in stock-picking.

Finally, the top balanced fund over the period of study was UTI us 95. Despite the controversies surrounding UTI, some of its schemes have done well in the market and have been among the top performers in various categories. Its last disclosed portfolio for June consisted of good corporate papers in debt as well as equity, including Reliance Industries and Infosys. However, its portfolio spans over 70 investments, and that can often be troublesome to manage.

So, what strategy do we suggest in these jittery days? Very simple: Pick the fund best suited to your risk-return appetite, and stay invested for the long term. When it comes to the stockmarkets, it pays to believe in the corollary to Newton's law of gravity: what comes down, must go up.

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