How a quarter can change fortunes. In the second quarter of 2002-03, not one equity mutual fund made a profit. Fast forward to quarter ended December 31, and-lo and behold-95 per cent of the funds make it home with not just gains, but an impressive average of over 11 per cent. Heck, even the scandal-rocked UTI managed to return to the positive territory. And that despite a series of shocks in the quarter. Alliance and Dundee announced plans to shut shop in India, and IDBI and Zurich too were reported to be keen on getting out of the mutual funds business. So, just what lifted funds' fortunes?

Answer: The rally in stockmarkets, led by the return of the disinvestment story, and a spurt in tech stocks due to a revival in it services growth. Bank stocks too gained, courtesy the passage of the Securitisation Bill, which allows banks to now seize assets of defaulters. Therefore, technology funds and funds with higher exposure to tech stocks made the biggest gains. The best performing fund Franklin Infotech Fund doled out a whopping 22.2 per cent return, with Pruicici Tech Funds snapping at its heels. Oil PSU stocks again flared in the quarter, and smart fund managers who had built up an exposure in those stocks made handsome gains. The sob story of the quarter came from an unlikely sector, pharma. All pharma funds except one made losses.

The trick in fund management, then, is not just in superior stock selection. Timing is crucially important. Ergo, while most of the fund managers have exposure to common stocks, their returns differ because of the timing of their entry and exit from a stock. In the balanced category, Zurich India Prudence Fund fared the best and posted an absolute return of 13.90 percent in the last quarter. This scheme is fairly consistent in its performance and has been rewarding its unit holders well. The fund manager has been maintaining a prudent mix of equity and debt, with exposure to equity hovering just around 60 per cent. Gilts comprise around 13 per cent of the portfolio, while corporate debt papers constitute the balance 27 per cent.

Bright And Cheerful

Talking about gilts, 'em shiny funds continued to glitter, clocking an outstanding average return of 6.25 per cent. KM K Gilt (Serial) 2019-Growth again dished out the maximum return of 14.16 per cent, with Tata Gilt Securities Fund-Growth following at 12.8 per cent. The best performing funds yet again were those with a long-maturity profile. With interest rates falling, long-term papers continued their march north resulting in handsome returns to investors. But, investor, take care. The high growth rates do not seem sustainable. KM K Gilt (Serial) 2019 has a very minuscule fund size of 1.13 crore and the entire money is invested in just one 17-year security. Tata Gilt manages Rs 150 crore of funds and has invested around 80 per cent in gilts, more than half of which have a maturity of about 20 years.

Debt funds also continued down the winning course. In general, it seemed that the higher a fund's exposure to long-dated government securities, the better its returns. Escorts Income Bond again was the best performer with a stellar return of 17 per cent, but there are some issues with the fund. It has high volatility and high NPAs, it makes irregular declaration of portfolios, and its size is minuscule. Sundaram Select Debt-Dynamic Plan came in at No. 2 with a return of 8.45 per cent. Around two-thirds of its portfolio comprises government securities. Similarly, Templeton Income Builder Account-Institutional Plan, PNB Debt Fund and Sundaram Bond Saver, the other top performing funds in the category, also have very high exposure to gilts. The average performance of all debt funds was a healthy 3.5 per cent in the quarter. They continued to post high returns in the wake of interest rate cuts.

Let's move on to liquid funds. As their name suggests, liquid funds have to maintain a highly liquid portfolio, sacrificing returns in the process. IL&Fs Liquid Fund Call Plan was a surprise entry generating a return of 4.44 per cent in the quarter. Others in the category managed a return in the range of 1.1 per cent to 1.95 per cent, with an average of over 1.55 per cent. The public sector mutual funds seemed better than their private sector counterparts at managing liquid funds. No wonder they ruled the roost last quarter among top performing liquid funds.

A Tricky Balance

Managing investments is invariably about managing the risk-return trade-off. The higher the risk, the higher the return investors expect. On the basis of risk adjusted performance measure, tax planning schemes and sector schemes were the best performers for the three-year period among all equity-based schemes. An analysis reveals that the funds posted returns higher than what was expected of them on the basis of risk taken by the fund managers. The analysis focuses on the returns generated by the fund managers due to superior stock selection by subtracting the risk-free return and market sentiment return from the total return generated by them.

In the equity category, tax schemes fared better than normal schemes, since the fund managers have the liberty to remain fully invested without worrying about redemption contingencies. The top five schemes included one tax planning scheme, two sector schemes of the UTI and two diversified funds-JM Basic Fund and Reliance Vision. Reliance Vision has been a consistent performer and has a diversified portfolio with exposure to mid-cap and small cap stocks. JM Basic, although classified as a diversified fund, has its portfolio completely stacked up with petroleum stocks. UTI dominates the list of top performing schemes with three schemes.

In the balanced funds category, Canpremium stole a march and displaced Templeton India Pension Plan from the top position it attained in the previous quarter. Both the top performing funds have been restricting exposures to equity and have about 60 per cent of their investment in debt and cash equivalents. And although their three-year returns have not been very attractive, the schemes have been able to diversify the risk for the investors.

Among debt funds, lower risk was the buzzword in a declining interest rate scenario. The top performer on the basis of risk adjusted return (calculated as the risk premium on total risk assumed by the fund manager) was Grindlays SSIF-Short Term that had taken the least risk. Its absolute return was not the best, but it got the maximum score due to its consistency in NAVs during volatile debt market conditions. Escorts Income fund came in second by restricting the maximum portion of its portfolio in state government securities, which showed less sensitivity to interest rate movements. Birla Income Plus slipped from its top slot in the previous quarter, but managed to stay among the best five by posting decent returns along with lower volatility in the NAVs.

In the gilts category, Alliance G-Sec led the pack and wrested the top position from DSP ML G-Sec Short-Term Fund. The DSP fund has been figuring on the list of toppers due to its low risk profile, although it has not been generating very high returns. The performance of the long-term offering from the same fund house (DSP ML G Sec Long Duration) has been in sharp contrast. It delivered its best performance yet, but still lagged at Number 3. The culprit: Its high risk.

Liquid funds too saw a new topper this quarter with JM High Liquidity rising above all the others. Again the performance in terms of returns was not very attractive, but because the risk taken by the fund was very low, it scored over its peers. Templeton India TMA offered better returns to investors when compared to JM High Liquidity Fund for one-year time period, but stood at Number 2. Reliance Liquid and Grindlays Cash also made it to the top five this quarter. jm High Liquidity has invested about 30 per cent in call money and 70 per cent in debt of short maturities. The average maturity of the portfolio stands at around 85 days, while Grindlays Cash Fund is higher at 135 days as on December 31, 2002.

What's in store for the last quarter of 2002-03? We don't want to hazard a guess on the specifics, but broadly equities seem set for a comeback. There are several reasons for it. One, Dalal Street expects fiscal year-end results to be in line with its expectations, and some FIIs are likely to step up their exposure to the Indian market. So go ahead, make your smart bets, but keep your fingers crossed and eyes peeled.