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Equity funds should diversify, avoid risk

Indian mutual fund investors should stress risk avoidance and diversification in their core holdings this year to avoid the battering they suffered in 2000, fund managers and analysts say.

"The year ahead will be turbulent," said Shekhar Sathe, chief executive officer at Kotak Mahindra Mutual Fund.

"Look for companies that create wealth and choose good managements for core portfolios across sectors," he said, adding investors with small holdings should allocate more to debt funds.

Last year, the dot-com flameout on the Nasdaq reverberated through domestic bourses which, coupled with a slowing economy, torpedoed net asset values (NAVs) of most equity schemes.

Of the 78 mutual fund schemes with varying degrees of equity exposure, a massive 88 per cent or 69 schemes, posted double-digit percentage losses, according to data compiled by New Delhi-based mutual fund tracking firm Value Research.

Within those 69 schemes, 15 clocked more than a 40 per cent negative return based on their December 31 NAVs.

Only six schemes out of 78 posted positive returns.

"This particular bad patch should work as a guiding post," said Dhirendra Kumar, managing director of Value Research.

With market volatility showing no signs of abating "it's about time fund managers proactively realign their portfolios in tune with realities" by going back to the mutual fund basics of diversification and risk avoidance, he said.

Many fund managers, swept up by IT fever, forgot about diversification last year.

At the peak of the equity boom, a majority of diversified equity funds had more than 60 per cent of their investments in software stocks and paid the price when the market tanked.

Bottom up approach

Analysts say that investors this year should look for mutual fund managers who have a highly selective, bottom-up approach and invest across sectors in companies with good managements.

For retail investors who want to bypass mutual funds, Sathe suggested they keep just a fifth of their portfolio in equities and the rest in safe haven government debt stock.

"And keep cash so that you can pick up bargains during turbulence," added Sathe, who manages Rs 10 billion.

Infotech sector funds were favourites in the first half of last year but now investors are sitting on heavy losses.

Despite this, analysts say investors should maintain an exposure to quality IT companies in the software sector.

"The Indian software services model is outstanding, more scalable and robust and there continues to be a large opportunity for quality IT companies to get a higher market share," said Bharat Shah, chief investment officer of Birla Sunlife Mutual fund.

"Our focus is to buy into good IT managements and strong businesses at a reasonable price and to hold on to the scrip," said Shah, who has Rs 40 billion under management. "The market may not fully reflect the business performance in prices but in the long term it certainly does."

Still, it may take time for investors to recover their nerve to invest in the IT sector.

Last year, nine IT funds collected nearly Rs 24 billion from investors accounting for 37 per cent of total mutual fund inflows in the first quarter of 2000.

That amount now has been eroded by 26 per cent on the back of the selloff on the tech-laden Nasdaq, which has came off by 52 per cent from its March 10 peak of 5,132.52 points after lofty valuations in the tech sector proved unsustainable.

Performance varies

Among IT funds, the Birla IT growth fund fared worst with a negative return of almost 50 per cent. The best performer among IT funds was the UTI software fund which posted a negative 29.83 per cent return.

Some analysts believe that investing in sector funds contradicts the purpose of a mutual fund.

"Sector funds go against the mutual fund philosophy where an investor not only looks for returns, but also diversifies to reduce risk," Kumar said.

Overall, the pain has been relatively less for investors in state-run mutual funds. Most of their NAVs fell last year by a smaller amount than those of private sector mutual funds.

The Unit Trust of India services sector fund emerged top of the heap among the 31 state-run funds with a return of 37.4 per cent. They were second best overall behind privately run J M Basic Fund, which invests only in petroleum and petrochemical stocks.

But all was not well for the Magnum series of funds managed by the State Bank of India funds management Ltd (SBIFM). It manages Rs 35 billion through eight equity funds which posted negative returns of between 31 and 50 per cent.

Still, analysts say that investors should remember that stock market investments are normally for the long haul.

"Performance is a medium to long-term measure. It should not be calculated for a time frame of a few months or a year," said SBIFM's managing director Niamatullah.

"I think markets have bottomed out and should come out of the bear phase," he added.

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