The Mutual Fund Show: What Makes A Top-Ranking Scheme

Piyush Gupta: Quant small cap is one of the most consistent fund as far as this category is concerned. This fund has been ranked number one in all the last four quarters that we have published.

So, if you look at this particular fund, it is slightly different from the other funds in terms of portfolio construction. One of the key thing that stands out for this particular fund is it maintains concentrated portfolio and significantly high amount of churn that we see in this portfolio, which means that the fund buys stocks for a shorter period of time, books profit and exits.

This also gets reflected when you look at the number of stocks that the fund has taken exposure to. So, more than 250 stocks, the fund have taken exposure in the last three years.

When you compare this with, say other funds within the category, it's about 140 odd stocks. So, the primary reason for its higher rank is of course performance. Some of its high conviction bets which have played out well over a period of time have helped in maintaining the topline ranking in this particular category.

Piyush Gupta: This particular fund, again similar to say Quant, this also has a relatively more concentrated portfolio. Some of the stocks for this particular fund is in the service sector especially have done really well, and which has meant that its return has improved over the last quarter when we did the ranking, the previous quarter versus the latest quarter.

What it also does is and again this is a small-cap category, the fund completely avoids large-cap stocks and have the higher allocation to small-caps and some of those stocks have actually played out well for this particular fund and ranking has improved.

Piyush Gupta:  I think it's always important to look at the consistency, why the ranking itself looks at consistency of performance over a period of time. But if you see a fund which has come in rank one, maybe look at how its performance pans out over the next few quarters, and then maybe look at those funds.

So, while you look at consistency of performance, it's always good to look at consistency in terms of the rankings that come out as part of this exercise.

Piyush Gupta: Yes. So, the Union is a fund which dramatically dropped in its ranking because of its performance. The fund suffered in performance primarily because of some of the stocks in the chemical sector.

In fact, the fund had higher exposure to the sector by almost 10% compared to 6% that the category has. This has meant that the fund lost out in terms of performance and also thereby declined in its ranking.

So, if you look at even the historical ranking, the fund in the latest quarter has of course ranked four and even in the previous quarters the fund has been ranked either three or two. So, to that extent the fund has never been ranked top in the CRISIL ranking.

Piyush Gupta: Yes, so for all our rankings across categories, we look at a mix of both performance and portfolio attributes. So, performance is where we look at returns. We also look at volatility of those returns, which means that a fund which has delivered consistent returns over a period of time, score well in the final ranking.

Apart from that, we look at portfolio construction. So, especially when we look at equity category, we look at factors like the extent of diversification. So, if there is a portfolio which is highly concentrated, that would mean that if their few exposures don't work out then the performance can get impacted adversity.

Hence, having adequate diversification is an important factor which is factored into our rankings. Apart from that adequate liquidity, while equity per se is a liquid asset class, still having adequate liquidity in the portfolio helps with the overall ranking that we publish.

Piyush Gupta: This is a fund which is consistently top ranked, either two or one, over the last four quarters. This is a fund which has a large-cap bias. This also helped in its performance in the recent quarter when large-caps have done better than the small and mid-cap universe.

Apart from some of the sectoral debt, for example, it had lower exposure to consumers and higher exposure to energy stocks. This has also contributed to its overall performance.

When we look at the portfolio-based parameters, it is a fairly diversified portfolio at a sectoral level. Fund also has slightly higher cash compared to category average. It's also to do with the fact that the fund on the asset side is significantly higher, but it's the largest fund in the category. That also helps the fund in maintaining more stability in terms of performance.

Piyush Gupta: Unlike ICICI Pru, which is the largest fund, this is another smaller fund in the category, close to Rs 150 crore. The fund’s performance has improved specifically in the last quarter.

We have seen that in the last quarter banking stocks, especially in the PSU space, have done well. This is where the fund had exposure, and which is where it benefited.

Apart from banking stocks, metals is where funds benefited from its exposures. So, some of these exposures helped in improvement in performance, which is thereby reflected in its final ranking.

Piyush Gupta: So, both funds, if you look at the latest ranking, they are ranked one and two. So, Parag Parikh is ranked one, this is a fund which we started ranking in the last two quarters. Before that the fund was not eligible in our ranking universe, from the time the fund has been ranked, it's always been ranked as one.

If you look at its portfolio construction, it's a portfolio which is concentrated in nature. The fund sticks to its high conviction bids. They have stuck around with those bids for a really long period of time, and which has played out well.

If you look at its portfolio turnover ratio, it is the lowest among the categories. So, that has helped in maintaining its higher rank in our CRISIL ranking.

Apart from that, the fund maintains a higher amount of cash. It's also partly to do with the fact that it is a concentrated portfolio where in order to maintain liquidity, they maintain a relatively higher cash. Now that also helps in maintaining stability in the performance of the fund.

Piyush Gupta:  I think the benefit is there in the old regime, in terms of 80C. If you move to the new regime, I think the benefit is not available with respect to 80C.

Piyush Gupta: So conservative or hybrid is the category where the investments are a mix of both equity and debt without dominant exposure. Being with the debt portfolio, there's a cap of 25% for equity exposure and the remaining goes into debt.

So given the hybrid nature, these are the funds which tend to give you stable returns over a period of time. Compared to debt, these are the funds which are expected to generate higher returns whether it's equity exposure and debt of course provides stability to the overall return.

In these funds, factors both in terms of allocation and the interest rate call, play out in terms of their performance, and the fund which is able to take those calls appropriately, tends to benefit in terms of the overall return.

Piyush Gupta: So, this is a fund which has seen a gradual improvement in the ranking over the last four quarters. In fact, if I go back one year, it used to be ranked at four. Then in the subsequent quarter it moved to three and now in the latest quarter it is ranked two.

Fund maintains higher allocation to equity, and this is a period when equity has done well, which has meant that its performance has remained better and the fund also maintains large-cap bias, which has in a way benefited the fund especially in the latest quarter.

Also on the portfolio risk factor, especially on the debt side, it is a portfolio which is dominated by government securities which means that the credit risk in the portfolio is lower. In fact, the government security exposure is close to 48% which is significantly higher compared to the category average. This also means that the liquidity in the debt portfolio is also superior as compared to the category average.

Piyush Gupta: Yes, I think ICICI Pru is a fund which has remained in rank two or rank three category in the last quarter. One of the factors that has led to its decline is performance or rather in ranking is the weaker portfolio quality. While it scores high on return and also volatility of returns, it’s the portfolio risk factors where the fund goes lower.

So, if I have to compare this fund vis-à-vis with ICICI Pru banking PSU which we will be discussing, this particular fund maintains lower allocation to government securities, higher allocation to security which are rated below AAA. So, with that the fund is able to generate a superior return or higher approval. It gets impacted in the portfolio quality parameters like credit quality or liquidity.

Piyush Gupta: Yes. There are two parts to it, one is the performance, and the second will be portfolio quality. The IDFC fund scores high on the portfolio quality parameters, and I would say it is consistent with all the debt portfolio that the IDFC manages, where we have seen largely their inclination towards having higher allocation to government securities, to AAA rated papers, with no exposure to lower rated papers, that also gets reflected in this particular fund also.

The fund, however, loses out on performance, this is also to some extent is a result of their lower allocation to equity. In fact, the fund has close to 12% allocation to equity, while the category average is around 20%, which means that superior returns that the fund can generate through equity allocation is something that doesn't work out for this particular fund.

Piyush Gupta: So, not sure in terms of what is their thought process of having a lower equity allocation. There's also one more observation we see, they have in fact reduced their large-cap allocation also within the equity space. So, both of them have actually not worked out for them in their performance in this particular fund. 

Piyush Gupta: Yes, so banking and PSU is within a debt space, it is a thematic category, I would say, in the sense it invest predominantly into issuers which are falling into banking or PSU space, which means that an investor who doesn't want to take credit risk in their debt portfolio, this is a segment that one can look at, given the fact that banking and PSU are supposed to be relatively safer from the credit risk perspective.

The fund category also has restrictions in terms of exposure to these sectors, so they need to have at least 80% of their portfolio invested into banking or PSU issuers.

The other factor one needs to remember is, unlike other categories in the debt space where there is a mandated duration bucket within which the fund is required to maintain their modified duration. This is a category where there is no limit in terms of modified duration.

So, to that extent, the interest rate risk in the portfolio can vary across the fund. There would be some funds which may go higher in terms of modified duration and thereby carry a higher interest rate risk.

So, from an investor perspective, one thing that they need to keep in mind while the credit risk is something which is controlled through these limited exposure, the interest rate risk is something that is there in these particular funds.

Piyush Gupta: So, if you look at this particular fund, the fund maintains rank one in the last two quarters and before that the fund was also ranked two. So, in a way, in the last three quarters, it has remained in the top ranked funds.

Again, when you look at performance and portfolio, this particular fund scores high on both performance as well as portfolio risk attributes. Its return has been higher than the category average over the last nine months, 18 months and 27 months.

Even on the portfolio risk contributes, it doesn't have any exposure to weaker sector, there is no sectoral risk in the portfolio. Even the portfolio is fairly diversified. There are no exposures which are beyond say 10% or 8%.

The asset quality is superior with the higher exposure to government securities. Also, the exposure to the government securities is through the floating rate papers, which means that the fund is able to manage interest rate risks to these exposures. So, the fund has superior portfolio quality along with the superior return that is helped them to maintain a high rank in this category.

Piyush Gupta: When we compare this with the other funds, the fund maintains superior score in the performance parameters, it has higher return, it loses out on the portfolio risk attributes.

It has exposure to issuers which are rated below AAA. There are some exposures which are at the issuer level beyond 10% which dilutes its diversification in the portfolio.

Also, the duration is something, while it is closer to the category, it has increased in the last quarter, which has also adversely impacted its ranking.

Piyush Gupta: Yes.