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Thursday, May 29, 2014

How did your Mutual Funds Perform?

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Don't look only at a fund's performance during a bull run, but also find out how it performed when the market was bearish.

Investors should not only look at how their funds performed when markets were booming but also during the bear phases. Now that the market is on an up swing, mutual fund investors will be keen to make the most of the situation. More so, as they have endured a torrid time for the past five years when the stock market was mostly range-bound and the NAV of mutual funds remained static. Most expect their funds to capture the rally and outperform the broader market. And, many funds are delivering superior returns. But, here's a word of caution for our readers: You should never judge a fund on the basis of its performance only during a market upswing. Don't get swayed by the recent chart toppers alone. It is in times of such euphoria that there is more reason to be rooted to fundamentals.

While your fund should be adept at making the most of an upside, it should also be in a position to protect your money during downsides. Here, we will dissect the performance of different categories of equity diversified funds, both during upturns and downturns over a three and five-year period. This will give us a better idea of how various funds have performed during different market climates. While an upside capture of over 100% indicates that a fund has outperformed the benchmark or category average during periods of positive returns, a downside capture of below 100% indicates that it has got higher returns compared to its benchmark or category average. For large-cap funds, the index used for calculating the capture ratio is BSE-100 and for small and mid-cap funds the benchmark index is CNX Midcap.


Upside does matter...


When you invest in an actively-managed equity fund for a fee, you expect the manager to beat the broader market at the very least.


If he is unable to do so, you would be better off investing in an index fund, which mirrors the returns of the benchmark index for a much lower fee. But, is your fund outperforming the index by a healthy margin of, say, 2-3%? If the markets are on a roll, chances are that it is. Most funds, including laggards, typically do well when the markets are climbing. Some even rise to top the performance charts, delivering phenomenal returns within a short period. And, therefore, it is easy to get lured by them.


There are many funds with a high capture ratio--it quantifies how far the fund has been able to mimic the market's movements. For instance, when the market moves up by 20%, and the fund moves up by 25% during the same time, it captures 125% of the market's movement or a capture ratio of 125. One would be inclined to invest in such funds. But will it be in your best interests to depend only on that performance before investing?


...but so does the downside Unfortunately, not many funds can outperform when the market is on a decline. When y the tide ebbs, you will find several of them barely managing to keep their heads above the water. The aggressive stance that helps certain funds deliver better returns during a market rally, typically results in a decline when the market turns bearish. Thematic funds, such as infra funds, have a very high upside as well as down side capture ratio. Thus, when the theme works they do exceedingly well, but during the downturn they are badly hit.

 

Sample this: JM Core 11, which has a very attractive upside capture of 138%, witnesses an even higher downside capture of 161%. In other words, the fund has clocked big gains during a bull run, but suffered heavy losses during downturns. Therefore, you must not go over-board on a category of fund just because they seem to be doing well at this moment. Ensure you remain true to your risk profile and asset allocation at all times.

Investors should, therefore, do well to identify funds that can perform well under both circumstances. But, only a handful of funds can boast of the ability to deliver higher returns during a bull phase, while limiting its losses in a downturn. Morningstar India data says that funds with a low down capture ratio have clearly emerged winners. If you screen funds on their five-year returns, those which have minimised their downside returns and maintained their upside equal to the benchmark are the top performers.

Mirae Asset India Opportunities, a largecap equity fund, which had a decent upside capture of 109% and a low downside capture of 77% during the five-year period, delivered a superb 23.82% CAGR. Interestingly, a lot of smalland mid-cap funds feature as top performers in the five-year period. In this segment, Religare Invesco Midcap has done particularly well, limiting the down capture to 68%, while giving a healthy up capture of 101%, and delivering a cracking 27.88% CAGR. You should ideally hold on to such funds that beat the benchmark consistently. These performers are likely to deliver good long-term results.

 

METHODOLOGY

 

An upside capture ratio of over 100 indicates a fund outperformed the benchmark during bull phases. A downside capture ratio of less than 100 shows that a fund lost less than its benchmark during bear phases. The upside capture ratios for funds are calculated by taking the fund's monthly return during months when the benchmark had a positive return and dividing it by the benchmark return during that period. Similarly, the downside capture ratios are calculated by taking the fund's monthly return during the periods of negative benchmark performance and dividing it by the benchmark return.

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