The figures have rarely looked so good. November saw equity funds in India generate their best monthly returns for the entire year 2004. The market's undercurrent was strongly bullish, with the BSE Sensex creating history on November 30, 2004, by closing at its (then) highest-ever level of 6,234.3 points.

This bull run can be attributed mainly to strong institutional buying, coupled with the softening of global crude oil prices. Foreign institutional investors (FIIs) have invested funds worth $7.3 billion (Rs 32,120 crore) in Indian equities over 2004 so far. Their favourites have been blue-chips, particularly in banking and oil sectors, but the rally has been quite broadbased, translating into a 9.91 and 9.62 per cent jump in the Sensex and Nifty respectively.

Peer Pressure

Mutual funds (MFs) have kept pace with the market, by and large, while also booking profits (they were net sellers during November). Diversified equity schemes posted an average return of 9.45 per cent, a huge increase against the 1.37 per cent return posted the previous month. The highest return among equity funds was posted by Alliance Buy India Fund, followed by UTI Banking Sector Fund, delivering 20.32 per cent and 19.71 per cent respectively. Among diversified schemes, the topper was SBI Magnum Multiplier-93, which posted a 19.39 per cent return.

Out of the 93 schemes analysed, 40 beat the Nifty and Sensex. November was the month of banking sector stocks, which took the baton from the tech stocks of the previous month's rally. The BSE Bankex posted a return of 19.25 per cent, against a meagre 0.8 per cent return the previous month. Bank-focussed funds, naturally, entered the limelight. Sectoral funds delivered an average return of 9.46 per cent.

Plan By Plan

Monthly income plans (MIPs) have been attracting attention for quite some time now, ever since equity markets started rising. These schemes balance debt with equity, and have done well because of that. The average equity exposure in this category was around 12.39 per cent in November, with UTI MIS Advantage Fund the topper, posting an annualised return of 31.64 per cent. The MIP category average, at 18 per cent, was way above last month's category average of 2.44 per cent.

Debt Relief

Debt (income) funds did better in November. After a series of negative returns, they re-entered positive territory. This can be attributed to the slight softening of inflation. Chola Income Plus was the best performer, posting an 8.80 per cent return, followed by Escorts Income Plan with 6.55. The category average return, though, was still a poor 1.04 per cent. Deutsche Insta Cash Plus ip was topper in the liquid funds category this time, replacing Principal Cash Management. It generated an annualised return of 5.22 per cent, while the category average was at 4.66 per cent.

In a volatile debt market, floating rate funds remain a safe bet, since they invest predominantly in floating rate securities, which are less sensitive to interest rate changes. DSP ml Floating Rate Fund has flared its way to this category's top, replacing Birla Floating Rate Fund LTP. It posted a return of 5.90 per cent, annualised, and has witnessed a huge increase in its fund size-from Rs 1,913.7 crore in October to Rs 2,687.6 crore in November 2004. More people appear to be discovering the floating rate advantage.

Watching Index Funds
Watching index funds should be easy, right? Not when there are tracking errors.

By Narendra Nathan

Among equity investments, nothing beats the simplicity of the index fund. The idea is to hold a portfolio that mirrors the stock composition of a popular index-thus tying its value to the fortunes of the market. With the BSE Sensex making new highs, index fund holders ought to be overjoyed.

Well, they still have something called 'tracking error' to worry about. Tracking error? It is simply an average measure of how much the return on your index fund varies from that of the underlying index. Its computation? If the return generated by an index fund on a given day is 5 per cent, and that by the index is 5.13 per cent, the fund's tracking error for that day would be 0.13 per cent. These daily errors are squared and added up for the last one year; the square root of this sum is then the tracking error value for the year.

But what causes these errors in the first place?

Expenses: These include asset management fees, agent commissions, brokerage and sundry expenses.

Dividends: These are not factored in by indices, but funds do earn them. The dividend yield of the Sensex stocks is 1.88 per cent; it helps beat the Sensex.

Cash components: Cash needs to be kept by open-ended funds for pay-outs. An index fund with 4 per cent of its corpus in cash would find that an index rise of 5 per cent gives it an NAV (net asset value) boost of only 4.8 per cent.

Trading activities: These occur throughout the day, while index calculations are made on the closing price data. Actual NAVs, therefore, could vary.

Market lots: Trading is done by rounding off investments, making it hard for any fund to mirror the index precisely. There will be some rough edges.

Market liquidity: This makes a difference because even index shares may not be easily available. This again makes it difficult to fine-tune the portfolio to match the index precisely (though index futures have helped smoothen things).

As visible from the table, exchange-traded funds have the smallest tracking errors in both categories. Why? "First, exchange-traded funds hold very little cash," says Rajan Mehta, ED at Benchmark Mutual Fund. Second, as they don't buy or sell shares from the market, they incur smaller expenses than do others. But keep in mind that here it is you, the end investor, who must pay the brokerage on the sale or purchase of these.