The Mutual Fund Show: Do Not Solely Go By Past Returns When Selecting Schemes

Kshitiz Mahajan: This is the most relevant thing which normally pops up when you look for fund performance. All the websites across various third-party platforms normally talk about past performance as the criteria.

I am not saying it's wrong, but it can't be the only criteria. People who are looking at it, they are… right at looking at how the fund has done over a period of time, but that can be one of the criteria. It can’t be seen as the only thing while selecting a fund.

Because eventually, you would like to see that strategy in which you are putting in money, irrespective of whatever they are doing, are they getting the return or not. So, that is also important.

The criteria to only look at returns can backfire big time because normally when you see mutual fund ads, past performance may or may not be sustained; it’s not in our hands. But at the same time, it gives you an idea about how the funds were doing over a period of time. Moreover, in past performance also, many people go to level two, they look at rolling returns…

Obviously, if you are in line with your index or little better than the index, it gives you comfort that without taking risk, it is able to generate better returns.

So, past performance in conjunction with your benchmark as well, as there are three-four parameters that one should look at while looking for a fund or shortlisting a fund. It can be a fund house strategy, investment philosophy, and consistency of fund managers in the fund. That also plays a very important role. In our industry, especially on the manufacturing side, the most important point is–sales and everything goes to the second level–is the fund management.

If you have a fund which is run by the same guy, with the same consistent philosophy, for say 7-10 years or 4-7 years, then you are a little comfortable with that fund house and fund manager. You understand his style and how he's doing things. So, that's one of the main criteria.

Then, there’s investment philosophy. If you are a value investor, it doesn't make sense to go for a growth strategy. You'd like to go for a value fund or a growth fund rather than just looking at options, irrespective of the strategy, because the performance is like this…

Lovaii Navlakhi: Unfortunately, the information to an investor that is available is limited to returns. You do not really get the sort of deeper insight that we, as investment advisors, might have access to or are willing to spend time and invest on.

One of the things I definitely think is important is rolling returns rather than point-to-point. I think even before you get to that, unfortunately, the past returns of the last one year, last three months, six months become paramount in decision-making by individual investors.

The question I have to ask them is what is the time period for which you are investing in that particular category. If you are investing with a three- or five-year outlook, then don't look at one-month, three-month, six-months return, because that's not the right comparison.

The other thing you have to recognise is that fund management styles of performance are cyclical in nature. So, at different points in time, there will be certain schemes that will underperform, certain schemes will outperform. It’s very difficult to determine how long that cycle is.

It's important to also then look at some risk factors, because investing is not all about returns. It's also about protecting from risk and one of the ways you might look at it is what's the standard deviation. How volatile is that fund?

As Kshitiz again mentioned, what have been the type of drawdowns. The example I can think of is if you have a fund which ends up giving you 9.5% in the last one year and last two years, both years it has given you 9.5%, and there's another fund which has given you 27% or 23% in one year, but -4.5% in one year. The average will end up being the same, but obviously, the fund which gave you 23% and -4% is a lot more volatile.

Again, that doesn't mean that volatility is bad. It depends on your risk profile. You like to ride and enjoy the ups and downs, go on a roller-coaster, then good luck to you. I don't like the roller-coaster. So, I tend to go to little more safer places...

Plus, there are many other things like the fund house’s ability, performance, what are they saying when they don't get it right because each investor, each fund manager makes mistakes. What did they learn from that becomes very crucial and important.

Kshitiz Mahajan: Interestingly, if you actually want to make the best use of past performances, look at SIP returns. It's a monthly input step which you do, and how the SIPs have performed over the last 3-5 years.

…The return for 2017 was so down that all mid caps and small caps had taken a 40-50% fall. Many of the clients who were going through various portals and investing into, for the first time they were coming in, they were just participating in mid and small caps without judging for the risk part.

So, the best part is the one year which has done so well will make the last five-year’s return look very good, but a rolling return is the right way of looking at it, how the funds have done over a period of time. Second is how the SIPs have done over a period of time… These are the two criteria which we look at.

We look at the beta part and… the drawdowns because that gives comfort that maybe taking little less of risk vis-a-vis the index, I am able to generate or beat my benchmark.

Lovaii Navlakhi: You really need to avoid sectoral funds if you can. For the lay investor, the simple reason is that if a particular sector is really doing well, in your diversified equity funds it will automatically gather a higher weightage.

You will get the benefit of higher returns from a particular sector when it is doing well, that's number one. Number two, the cycles for the returns for these sort of sectoral funds is a bit sharp, in the sense of the return that you might make as well as the negative that you might pay.

Therefore, when we think of investing and equity investing for the long term, the sectoral funds don't actually fit the bill in that way unless you are willing to fill it, shut it, forget it.

For most people, because NAVs are visible, it is difficult to ignore. Then, you look at and say, ‘Oh, should I exit this fund?’ Then, if you get your timing wrong, you are caught at the wrong end of the cycle.

IT, as a sector, we do like. It's a good idea to have exposure, etc. But when the going is good, the diversified equity funds will have higher exposure and you will benefit from that.

I am not so sure for the lay investor; for the more advanced investor, yes, but then be ready for in and out a little more frequently and the impact therefore on capital gains, etc. You are willing to take that, then it's worthwhile looking at sectoral funds.

Kshitiz Mahajan: So, I will just compare ourselves with emerging economies where IT participation in the broader index, not Nasdaq, is 30-31%. We are at 19-20%, of late. None of the funds are in line within India’s strategy, around 18-19% also. Most of the funds are in 13-15% in a large-cap or multi-cap or a flexi-cap fund.

Now, I am coming from a different view that funds, or let's say any strategy, which is not only having technology stocks, but those businesses also which are having technology as a catalyst–output can be anything, it can be fintech, insurtech, food tech, anything. Those types of portfolios should be looked at, rather than just looking at technology stocks–those businesses which are using technology as the catalyst to move to the next level, which are actually integrating their back-end and front-end through technology, can be looked at.

We are in a digital India phase and this decade is a total tech decade for sure. Now, maybe 2030 onwards, some new concept will come in, but this decade belongs to technology. …That throws a lot of opportunities also. There are many portfolios–I don’t want to name them–many strategies which focus on the digital India theme, and where they are imbibing technology at the next level for growth.

Those funds, those companies should do very well in the coming months. So, I have a very strong conviction that this sector is much wider, broader than what we think. It is actually growing horizontally. More and more companies are coming to this space.

Kshitiz Mahajan: Yes, there are options out there. I like a couple of them. I am talking to their fund managers and am looking at their portfolios also.

Once you go through the portfolios, you also see that change, which I am talking about. Being a sector growing horizontally, they are also incorporating lot of those businesses which are not a tech-tech company, but they are offshoots of tech companies. They are now realising that the next level of growth will come from tech.

…Yes, I am talking about it from a retail perspective also. This can be categorised into a sectoral allocation and can’t be more than 5-10% and long-term 5-7 years is what view one can take while participating in these types of businesses.

Kshitiz Mahajan: So, these are not recommendations; they are something which I like from my side. First is an offering from ICICI Prudential Technology Fund and second is from Tata India Digital Fund, which are the schemes I like.

Lovaii Navlakhi: The technology funds tend to concentrate in the same sort of places, which are known places; they don't necessarily go out to these other businesses that you were talking about.

In the technology funds, from what data I read, almost 77% of the holding is in the top 10 stocks. …That extra that you are looking for, and that then becomes a stock-picker ability to say this particular fintech or food tech–and maybe it even gets into private equity–is really going to outshine the rest in that particular sector. So, for the lay investor, I don't really know whether you are getting that oomph factor in your investment that you are looking for.

Kshitiz Mahajan: What I have learned is that there is enough food for everyone. All these new players, they are coming with a big bang. We are a young, tech-savvy nation. More than 60 crore of our population is under 40, and these all-new, low-cost offerings which are coming, they are more on the tech side, on the AI side… They are saying let’s cut human intervention.

So, somebody who's into fixed deposit or recurring deposit accounts, they are looking at participating in equity, and index is a good way of participating in equity….you can easily make 11-12% through index fund route.

And then, they are cutting the cost because cost is one element which obviously over a period of time, can actually pull down or drag the return down.

…So, there are many such new businesses which are coming with low-cost index funds, which are coming with factor-based funds, and there is enough scope for them to grow.

Many new clients coming to the industry, they don't want 40-50 stocks to analyse, they want to focus on different products and different style of things.

So, a couple of AMCs have thought of having their one flagship fund and they are just focusing on that fund only, let's say the PPFAS or Quant Mutual Fund. They are very clear that’s how they want to grow. They have their flagship strategy, value-based theme… and their clients also are liking that they are not diverging into so many other funds.

At our end also, whenever we are talking to anyone, we also always say that let's keep it short, rather than just diversifying. End of the day, you over-diversify when you invest in too many schemes. That also drags your returns down.

You don't have to have so many schemes. So, these low-cost offerings which are coming,... they are getting some allocation on their side.

…There is a thought wherein they are going for factor-based funds also, which is the best of both worlds. You have passive management and active management. You take the middle way, you take the best of both worlds.

You eliminate a few factors, you keep a few factors, momentum on let's say high dividend or whatever strategy you want to and you go for those types of funds also.

So, they are getting some allocation on both sides, and I see that both strategies–the active management… and the passive management, and the new which is low cost as well as factor-based strategy is going to coexist. So yes, that can be looked at also.

Lovaii Navlakhi: Whenever any new fund house comes in and there is a new sort of launch, what is important to know is what sector or what category are they reaching out to, and if that particular category did not exist, then for sure we are happy to look at some of the newer offerings.

But we find that if it is just a repetition and it’s a similar strategy as many other existing ones, then we would rather wait to see the track record before we jump in.

Some of these newer strategies like the low-cost index funds that Navi is coming out with, or the Quant strategy, or now I can see even maybe relatively older fund houses like Motilal Oswal saying here is the momentum strategy, a low volatility strategy on top of an index.

It's sort of filtering through the index and meeting a particular client’s need. Those are things that you can sort of mix and match for the client. I think suitability is very important, that the new strategy is something that the client wants.

For any new product, there will always be first-time adapters, who will say as soon as something new comes, I want to try it out and there will be others who will wait and watch and say let me see how this performs before I jump in. To each his own.