IDENTIFYING THE BEST AMONGST MUTUAL FUNDS

Last week, I suggested you to get familiar with some mutual funds information such as the list of best performing mutual funds over a certain period of time, looking up the fact sheets of mutual funds and the like. I hope that you have taken time to do this, as this data becomes our primary source of research to identify our best picks amongst mutual funds.

In case you had not seen the data, you can have a quick look at the following links, for understanding the same:

1. Here is where you can play around and see the best performers over different periods,
amongst different types of funds, etc. For example, you can query for the Top 10, gainers over the last one month, amongst open ended, equity-diversified funds, and you would see results of the following type:


Likewise you can query for a different period, different types of fund schemes and the like.

2. Factsheets for mutual funds are available to research specific schemes. A typical
factsheet would look something like this:








The above two data factors are excellent starting points for deciding on the mutual funds to invest in.

For the present discussion, I will continue to focus only on the mutual funds that are open-ended, diversified equity based ones. There are ample options amongst this type, to choose from.

In other words, what I am filtering out, for the present decision making, are debt funds, short term liquidity funds, and even balanced funds. For information, balanced funds balance their investments between debt and equity. While these are good investment bets at certain times, for the present, especially for purpose of our discussions, why dilute the equity based
investments, even with a small percentage of debt? As such, I am looking at pure equity based mutual funds, for now.

Before we get to the decision making process, let me explain some more fundamentals with regards to mutual funds:

1. Mutual funds, as you would appreciate, reflect the value of the overall investments made by the fund. If most of the equity picks of the mutual funds are doing well, the mutual fund appreciates. However typically mutual funds spread their investments in several shares, and not all of them go up each day. Due to the slight balancing that happens
   between the winning and losing stocks from the mutual funds portfolio, the increase in the value of the mutual fund is usually a gradual one, even in good markets. To be more precise, you may find a particular share streak up by 10 to 20% on a single day, but that kind of streak is less likely to happen with a mutual fund value.

2. On the other hand, the right picking of stocks by the investment managers of a mutual fund, usually ensures a steady movement upwards. In a longer phase, say 3 months and upwards, a retail investor may generally find better rewards in a mutual fund, than in his own direct equity investments.

3. The price of a share is often subject to some 'resistance' levels. For example, a share hovering in the Rs. 80-90 range may inch up towards Rs. 100, but may not penetrate the Rs. 100 level. It may reach Rs. 99 and again retreat down. This is on account of Rs. 100 being a resistance level for the stock. In other words, a lot of investors could have put "sell" orders for Rs. 100 levels, and the price keeps falling down, as it approaches Rs. 100. In case of mutual funds, since the price is never directly determined, but is always a "net asset value" based on the prices of the individual stocks invested in, therefore, there is no question of any resistance levels. If the individual stock investments of the mutual fund are doing well, the NAV of the mutual fund will keep increasing irrespective of the value it is at.

4. Some mutual funds do well in the short term (say, 1 to 3 months or so), and others do well in the longer term (6 months - 3 years, say). This performance would be on account of the specific nature of the mutual fund, in terms of its investment profile, as also on account of market factors. To explain more clearly, a mutual fund may have a steady, long term investment style (e.g. Franklin Bluechip Fund). Pick some good picks, and stay invested for 1-3 years, say. Not much of a churn in their investments. They believe in the stocks that they pick, and are sure that in the 1-3 years perspective, those stocks are going to deliver good returns to them. Then, such mutual funds will almost certainly do better than other mutual funds, in that longer term perspective. They may rank high on the
   'best gainers in 1-3 years' period. However as they do not churn their portfolio much, they may miss out on some shorter term opportunities that get created. They may not feature in the best performing mutual funds in the 1-3 months period, then. Likewise, say a mutual fund has a stated investment objective of investing in mid-cap stocks (e.g. Franklin Prima Fund). Then, if it so happens that the market gives a sudden, tremendous appreciation to mid-cap stocks, then this fund is likely to zoom up in the shorter term. As
   has happened with that fund, few times, in fact. You would therefore find this fund to be amongst the better performers in the short term (1-6 months) in such periods.

5. As a retail investor, you MAY be sure as to what is the time frame that you want your returns in. Say, you want to get good returns in a year, then it may logically follow that you look at the 'best performers in the 1 year period' list to start with. However to this, I have to say that it is quite likely that the best performers in the one year that went by may not be the best performers in the coming year, when you are investing. It is possible that the last one year say, was good on mid-cap stocks. And now, since the mid-caps have already appreciated a lot, then, the coming year may not see that growth, and could even see some retreats. Then a mid-cap mutual fund that has done well in the last year, may not necessarily be the top performer over the next year. And you may make a mistake by investing in that fund.

6. Another factor to look at, from the factsheet of the fund, is the overall mix of investments of that fund. There have been funds which, at times, have had a very large exposure to a single stock, or to a single industry. Your very purpose of investing in a mutual fund (as
   against, making direct investments into equity markets yourself) is to hedge your bets. Not to bet heavily on a single stock or a single industry. Then, if the mutual fund that you invest in, has a high exposure to one stock or one industry, it is that much more susceptible to a sudden drop in its value, should that stock or that industry go down suddenly. Not more than 7-8% exposure to a single stock, and not more than 20% exposure to a single industry is a good idea, and you may look for the same, in the factsheet of the mutual fund.

7. The fund house is also an important factor in the selection. There are many new fund houses that have come up in recent times and they have not proven themselves in the long run yet. Also they may not have large corpuses of assets to weather some storm, if it comes about. Likewise, one may also look at the ethical background of the fund house.
   Like in case of equity markets, where I had suggested to stray away from any equity where the promoters or management have any negative factors associated with them, so also in case of mutual funds, if the fund house has any 'negativity' associated with it, stay away. Simply because there are other options on offer, so as a retail amateur investor, why play with fire?!

This is good time to recoup on the fundamentals discussed so far. Above are the various factors that you would look at while shortlisting your mutual fund picks. Further the data for your research comes from the list of top performers and the mutual fund factsheets, referred at the beginning of this article.

Considering this ammunition, I would suggest you to start by shortlisting the fund houses that you 'approve of'. In short, make your first selection, based on your "feel" about mutual fund houses. You may think that Alliance Fund has been in the news for some wrong reasons and you do not want to consider it, or you may think that with the Ambani problems, it is a good idea to stay away from Reliance fund house too. And you may think that the Sahara Mutual Fund is too new for consdering at this time. And so on. This part of the selection is your own 'feel' as each one may have their own perceptions on these factors.

Doing such pre-selections, say you end up with the following fund houses as your approved ones:

Birla, DSP Merrill Lynch, HDFC, HSBC, Sundaram, Tata and Templeton.

With this pre-selection, now we do some simple spreadsheet work. Yes, even an amateur investor is expected to be comfortable with basic MS-Excel working!

What we do is to look for schemes from the short listed fund houses, and record their NAV growths, over different period of time, like, 1-month, 3-months, 6-months and 1-year. This data is tabulated in the spreadsheet. (** Before you start wondering if this is going to be a weekly
exercise that I propose, rest assured it is not. It is a first time activity to select the initial investments, and something that you may want to review once in 6 months or so.**)

Once this data is tabulated, use this great and simple feature in Excel which is to fill the cell with a colour. Identify those performers which are ranked in the top-3 or top-5 (whatever benchmark that you may like to choose) and for such cases, fill the cell with a certain colour.
What you will get is a table that looks something like this (this table is made for data on Oct 10th, 2004):

The purpose of the colouring of the cells is to give a quick visual impact, as you can see from above. What has been done is that all the schemes that rank at the very top in a period have the cells coloured in blue, those that rank second level are coloured in orange, and those that rank
third level, are coloured in yellow.

As mentioned earlier, for a retail amateur investor, it may be a hard call to take in going for specific period targets, and following the best performers in that period, e.g. investing with a one year perspective and hence picking the best performers in the one year period category. As conveyed earlier, last one year's best performers may not be the best performers over the next one year.

Then what I would look for, is which funds have done reasonably consistently well. Which funds have the most coloured cells, or in other words, their performances have figured in top 1-3 position levels, over different durations of time. What I would read from that is that the investment team of that fund is able to sufficiently tweak its investments, to maximise
returns over different periods of time. As a retail investor, I would find most comfort in such funds, then. In the above table, of course, if a fund had all blue rows, it would be a dream come true. That not being the case, one looks for most blues, oranges and yellows, in that order. One can even give weightages to the colours. Say, 3 points for blue, 2 for orange and 1 for yellow, and see which row has the highest score. And based on that, pick your favourites. Once that choice is made, a further evaluation of the portfolio of the fund (from the factsheet) to ensure that it has reasonable diversification leads you to the final selection.

From the above list, it would appear for example that, the following funds are best picks:
Tata Equity Opportunity
HDFC Capital Builder Growth
Tata Select Equity
HSBC Equity Growth
Sundaram Select Midcap
Tata Pure Equity
Birla Midcap Growth
Franklin Prima Fund Growth

Just to remind you, the above exercise is not of recent NAV values, but of Oct 10th, 2004. But the conclusion that you draw such an exercise gives enough conviction to opt for these funds for investment.

Pardon for a little excess technicality in this piece, but I still believe, this is as technical as an amateur investor can understand, and is certainly not beyond him. Do try and appreciate the points made here, even if you need to go through this piece a couple of times. To tell you the fact, I managed to pick HDFC Capital Builder from the above exercise, when none of my
mutual fund agents had suggested the scheme to me yet, and its done very well since, as I would expect from the theory above. When you take decisions based on your own sound thinking, you usually have a lot more confidence, and are likely to stay with your choices, which have come from better conviction than simply having got a referral or a tip from someone!

To conclude now, a take on the markets for the next week. All day today, we have been hearing of the huge natural calamity that has struck Asia and also large parts of India. Where the markets have been able to tide over most other hiccups over the last several months, because of strong fundamentals and huge FII inflows, a natural disaster of this nature is something that the markets may not take too well. Anyway the markets appear to be overheated, and a massive tragedy of this nature is the prompt that may finally drive the markets to a significant correction next week. Add to that, there is the Ambani confrontation in terms of the RIL board meeting, where also more sparks are expected to fly. So brace yourself for some downward movements next week now. Those who are convinced of the fundamentals and the India story
might just look at this correction as an opportunity to buy, and those who panic for their large losses to get wiped out, will sell quickly!

Till next week, then.. au revoir.

- Sanjay Mehta