Mr. Viral Shah
Principal Officer, NJ Advisory Services Pvt Ltd.
Mr. Viral Shah has been preparing various strategies for PMS investment. Prior to joining, NJ Advisory Service Pvt Ltd., he worked as Research head at NJ India Invest Pvt. Ltd. and looked after mutual fund research, portfolio review and managing portfolio of NJ group companies and select corporate clients.
Viral: 0n 31st July, India's key indices closed at an all time high of over 11,356 for NIFTY 50 and over 37,606 for BSE Sensex. The past year has seen these benchmarks rising sharply from ~9,600 and ~30,000 levels for Nifty and Sensex respectively, to the current levels. Not surprisingly, the past year has been a rollercoaster ride for these benchmarks, often making newspaper headlines and attracting our attention.
There is positive sentiment in the markets, the indices are breaking their own records and things are going great but amidst this wonderful scenario, the mutual fund investor is left with one big question -
“When markets rising, why is my mutual fund investment falling?”
This is one common question that we have from our financial advisors, since the mutual fund NAV's aren't following the rising curve of the key benchmarks. The primary reason at the root of the quandary is discussed herewith. The table shows average returns data of Large Cap and Diversified mutual funds over the last 6 months and 1 year periods pitted against the benchmark.
| Mutual funds category | 6 Months | 1 Year |
| Large Cap funds | (-) 3.00% | 8.40% |
| Multi Cap funds | (-) 6.08% | 7.07% |
| Mid & Small Cap funds | (-) 12.12% | 4.53% |
| Nifty 50 TRI | 2.59% | 14.09% |
Source: NJ Internal. As of 30 June 2018.
As we can see, lately the Large Cap, Multi Cap and Mid Cap mutual fund schemes, all have underperformed the key benchmark, Nifty 50 TRI. This difference in returns is puzzling for most investors, and it is natural because most of us do not really understand the reason for this difference. Mutual funds, with all its benefits viz. diversification, superior stock selection, professional management, etc., are expected to deliver alpha performance over benchmarks. But looking at the present scenario, not surprisingly, most of the investors are in a dilemma with respect to their investments.
Understanding the difference in returns:
If we want to put it in one line, it'll be like – 'the markets are largely driven by a handful of stocks and the broader markets have not performed as well as the top few, in the recent past'.
In an attempt to decode the phenomenon, we broke the performance drivers of the Nifty benchmark to understand it better. Here are the key findings of this study, done for the period ending 30th June, 2018 for one year & 6 months periods.
In the graph below, the Y axis represents the absolute contribution of a particular stock to total Nifty returns. The X axis is the spread of all the stocks which formed part of Nifty, sorted in decreasing order of their contribution to Nifty returns.
Source: Blooomberg. As on 30-06-18.
As can be clearly seen, the few stocks contributing the maximum to total returns are concentrated at the beginning of the curve.
We have put the above chart in figures, for the one year period:
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Of all the stocks forming part of the Nifty, only 35 stocks contributed positively to the Nifty. The negative stocks took away an absolute 4.1% of the returns from positive stocks, which totaled 18.2%.
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The returns from the top 3 performing stocks alone contributed an absolute ~7.4% of the entire Nifty returns of 14.09%. Their average weight in Nifty was much less, about 22.4%.
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The top 7 performing stocks contributed nearly 13% absolute to the entire Nifty returns meaning thereby that the remaining all stocks cumulatively only managed to add ~ 1% return to the Nifty.
Even for the six month period, similar returns attribution can be seen, with even higher concentration of few stocks in the positive line. It is interesting to note that, for the 6 month period, only 20 stocks contributed positively and their returns totaled 8.65%. The rest of the stocks took away an absolute ~ 6% from the Nifty returns for the final Nifty returns of 2.59%. The top performing stock alone was responsible for 53% of the net returns.
The primary reason - behind the gap between the markets and mutual fund returns, is very simple - a few big stocks have driven the returns of the index. Had it not been for the few top liners, the Nifty too would have delivered negative returns in the 6 month period and flat returns over the longer period under observation. Without the few performing stocks, the Nifty returns would have either matched or rather underperformed Mutual Funds. Hence, in the recent past, few investors have made returns while most investors are left unimpressed with their investments' returns.
Q: What makes the composition of mutual funds different from indices?
Viral: One question that may arise in our minds is, What's the composition of the stocks in the index, like Nifty, and how is a mutual fund scheme different. The point to note here is that a theme driven fund has a much larger universe of stocks available for selection. For a large cap fund, the fund manager is free to choose from the top 100 stocks on basis of market cap. The fund manager makes his selection with the objective to generate better returns in the long term and with appropriate diversification. As opposed to this, the index is an automated composition of the stocks starting with highest market cap. It may be possible that the top performing stocks do not form part of the large cap fund and/or carry similar weight-age to influence returns. Hence, the difference in returns of the large cap funds vs. Nifty.
Q: What about the small and mid cap funds?
Viral: The past year has seen a lot of investors investing in the mid & small cap and multi-cap funds which have delivered negative returns of over 12% and 6% respectively, over the 6 month period ended 30th June 2018. The respective indices have fared even worse with Nifty MidCap 100 and BSE SmallCap delivering (-) 13.97% and (-) 16.63% respectively, for the same period. The primary reason for this negative performance is the fact that a huge churn is happening in the mutual fund portfolios which have moved from small & mid cap stocks to large cap stocks as per the new regulations. Adding to this, is the fact that small & mid cap stocks are more volatile and more sensitive to market volumes. The result could be seen in the returns of small & mid cap funds and also diversified equity funds, which had these stocks in their portfolios. It would be thus unfair to find faults in funds or the fund managers' performance.
Q:Should I worry or review my portfolio?What's the way forward?
Viral: The answer is “No”, if the review is only driven by the short term returns anomaly.
It's time to get back to the basic principles of investing in equities and reaffirm our conviction in equities and the Indian growth story over the long term. No reason to wander off track, especially now.
Let us remind ourselves again that in short term, markets or funds may get affected by short term events or sentiments, but in the long run, the underlying fundamentals will have a bigger role to play. If you look at the historical returns, mutual funds tend to outperform the benchmark indices by a good margin, as seen from the table below.
| 5 Years | 10 Years | 15 Years | |
| Average of Large Cap Funds | 16.36% | 12.88% | 18.58% |
| Average of Blend / Multicap Funds | 18.73% | 13.68% | 20.22% |
| Average of Midcap Funds | 24.47% | 17.16% | 23.34% |
| Nifty 50 TRI | 14.30% | 11.59% | 17.75% |
| Nifty MidCap 100 TRI | 21.32% | 14.76% | 21.11% |
Source: NJ Internal. As of 30th June, 2018.
We believe that superior stock selection and diversification will give us the alpha we desire from mutual funds. In fact, the low prices present an opportunity to invest. It's time not to disrupt but to continue and even start new SIPs in small and mid cap funds. It's time when SIPs will capitalise on lower stock prices with lower fund NAVs resulting in you getting more units. It's time when SIPs will work their magic for generating superior long run returns.
Bottom line, ignore the market noises, stick to basics, have patience and reaffirm your conviction to the funds you have selected and to the Indian growth story. There is one more thing you can do - enjoy the fresh air, the greens and the cool climate brought to you by the Indian monsoon! Thank you and happy investing.
