Large-cap funds' bets on small companies backfire

UTI Leadership , Reliance Equity, Bharti Axa Equity and Sundaram Select Focus funds led the under-performance of more than half the large-cap equity schemes in 2010 as fund managers stacked up small companies in their portfolio to outperform, a strategy that backfired and strengthened the case for investing in index funds.

Nearly 37 of the 61 funds run by Reliance Mutual Fund, UTI Asset Management and Sundaram Mutual Fund returned lesser than their benchmark indices as mid-cap and small-cap companies lost value faster towards the end of the year on the back of a series of scandals. The returns of these underperforming funds ranged from -0.8%% to 15.8% in 2010, when the Sensex rose 15.6% and the S&P CNX Nifty gained 16.09%, data from Value Research, a mutual fund tracking company, shows.

"Fund managers wanted to have a diversified portfolio with mid-cap stocks to give the return kicker," said A Balasubramaniam, CEO, Birla Sun Life Mutual Fund. "In most cases, however, the strategy of seeking alpha by investing in mid-cap stocks misfired. 2010 was a year of rapid market movements; such volatility required faster alignment to broader markets. Most fund managers failed to keep their portfolio in line with the markets," he said. Alpha refers to the risk-adjusted return on investments.

The underperformance has dealt the 6.65 lakh-crore mutual fund industry, which has been facing tough times ever since the 2008 meltdown, another blow. Due to the poor performance of equity schemes, Indian investors who keep more than half their savings in bank deposits, may increase their investments in fixed-income securities as interest rates climb.

Poor performance of some of the index constituents such as Reliance Industries and metals company Sterlite Industires also added to the woes of these schemes.

The dwindling optimism about Indian markets' prospects due to soaring commodity prices and the possibility of higher interest rates may make it difficult for funds to provide market-beating returns in the new year, too. "2011 may also not be a great year for equity mutual funds," said Dhruva Raj Chatterji, senior research analyst, Morningstar India, a fund research firm. "Equity funds are likely to generate just about 10% from the current market levels. Equity funds outperformed in 2009 only because of the lower performance base created in 2008. The course ahead will be difficult for fund managers. Risk-averse investors should start looking at balanced funds."

Foreign fund flows may also be lower than the record $29 billion this year as investors begin to buy equities in the US and other developed markets, where the prospects are looking up. Fixed-income returns have jumped more than 50% with the yield on the 10-year US treasury jumping to more than 3.5% from less than 2.5%.

Mid-cap and small-cap companies that provide higher returns fell off investors' radar in the last quarter after the Securities & Exchange Board of India revealed price rigging in companies such as Murli Industries and the Central Bureau of Investigation arrested some bank executives for taking bribes to sanction loans.

Among funds that have outperformed are Religare PSU Equity Fund, with over 11% return versus the benchmark return of -1.42%, Reliance Equity Opportunities at 29%, Magnum Emerging Business at 30% against the benchmark's 15%, and DSPBR Microcap Fund, which clocked 43% returns versus the 15% gain of the BSE Smallcap index.

Source: http://economictimes.indiatimes.com/markets/stocks/market-news/large-cap-funds-bets-on-small-cos-backfire/articleshow/7181937.cms