Category Archives: Mutual Funds

Carnage in Mid & SmallCap Stocks pulls down MF Returns

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Greetings from PenguWIN:

                                        Over the past few weeks, I received questions from half a dozen investors on the performance of the Equity funds and wanted to know whether their portfolio needs to be rejigged. My answer is “please hold” as it’s a phenomenon across different categories of funds, pronounced in Small and MidCap funds. The Sensex and Nifty are at all-time high with returns of 2.57% and 4.87% over the past 6 months while the mid and small caps have been battered with negative returns of (11.42%) and (16.46%). Over 50% of Mid and Small Cap stocks listed in NSE have lost more than 25% of their value.

            I am outlining some of the key reasons that has resulted in this poor performance.

  • Huge valuation of Mid and Small Cap stocks. Typically, in the past Mid and Small Cap stocks have traded at a discount to LargeCap. However, in the recent run till 2017 end, Mid and Small Cap stocks were trading at more than 200% of Price to Earnings of LargeCap (Nifty and Sensex)

 

  • SEBIs mandate on Categorization and Rationalization of MF Schemes in Oct 2017. Mutual Funds did not have clear definition of boundaries of Large, Mid and Small Caps and each fund house had its own definition. There were also multiple schemes of the same category, like 3 LargeCap funds in the same fund house. As a result of the SEBI mandate, fund houses have to merge/modify existing funds and also clean up the stocks that a scheme owns. Many funds, even Large Cap had sizeable allocation to Mid and SmallCap stocks forcing them to sell to adhere to SEBIs definition. When all fund houses tried to reduce their Mid and Small Cap stocks at the same time, there were not enough buyers resulting in steep valuation drop. Thus, MFs pressure to sell Mid and SmallCap stocks was a key driver

 

  • Surveillance Measures. Mid and SmallCap stocks are happy playgrounds for speculators and valuations go sky high without any change to the company fundamentals. SEBI in coordination with the BSE and NSE stock exchanges had been subjecting speculative stocks to surveillance measures since 2017. This covers both the changes not attributed to the fundamentals of stocks and also high volatility. Some of the highly traded stocks came under the scanner resulting in steep falls in price.

 

  • Governance Risks. Governance issues have surfaced among Mid and SmallCap companies where Auditors like Deloitte and PwC quit just before the results announcement citing inadequate disclosure. Auditors of over 30 listed companies have quit in 2018, till date, wherever they doubted the veracity of numbers. Both individual as well as institutional investors were caught unaware resulting in a selling spree bringing down the valuations to more than 50% in many stocks

 

Conclusion: While the Mid and Small Cap stocks correction might continue further, investors with higher risk appetite, investing systematically, will be rewarded handsomely. Just make sure that your asset allocation commensurate with your Risk Appetite and Risk Tolerance.

I believe the returns on investment in the poor are just as exciting as successes achieved in the business arena, and they are even more meaningful! - Bill Gates

<Blog # PenguWIN 1061 – Carnage in Mid & SmallCap Stocks pulls down MF Returns>

Mystery of Missing Returns

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Warm Greetings from PenguWIN:

            I wanted to share this message with you before you might observe and become anxious. A couple of our investors have noticed it and requested for clarification. It has no effect on the value of the fund but portrays the performance in poor light. The details might be slightly technical (no impact to you) which is the reason why I was holding this message but thought that this note be shared when investors started asking for the clarification.   

The Categorization and Rationalization of Mutual Fund Schemes was initiated by SEBI, last year, to ensure that the schemes are clearly distinct in terms of investment strategy, asset allocation, uniformity in characteristics of similar type of schemes to help investors take informed decisions.

SEBI had discussed this with the MFAC (Mutual Fund Advisory Committee) and as a result of deliberations, the committee proposed the following changes in Oct 2017 to be implemented by the fund houses by June 2018.

  • Group Mutual Fund Schemes, into 5 groups including Equity (investing in stock), Debt (investing in overnight securities with 1-day maturity, money market, debt for varying durations), Hybrid (mix of stocks and debt instruments – typical balanced funds), Solution Oriented (Retirement, Children) and others (Index Funds, Exchange Traded Funds, Fund of Funds, International Funds
  • Rationalization of the Market Cap (product of no. of shares and prevailing price) definition by ranking them in descending order:   
    • Top 100 companies in terms of market cap to be referred as Large Cap
    • Companies with market cap from 101 to 250 market cap to be referred as Mid Cap
    • Companies from 251 and above in terms of market cap to be referred as Small Cap

 

This exercise resulted in Mutual Funds to adopt a uniform definition of Market Cap which was different for each fund house earlier as there were no standard definitions, like a small cap company as per Fund house A referred as mid cap company by Fund house B. The exercise also limited fund houses to have only 1 scheme per category, specifically in Equity, Debt and Hybrid resulting in merger of funds, changes to attributes and nomenclature of funds. In the past several fund houses had more than 1 Large Cap, Mid Cap, Balanced Fund and so on.  

As part of the merger of 2 funds into a new category, the assets from each fund had to be transferred into a new pool and either 1 of the exiting fund managers or a new fund manager had to be designated as the fund manager for the merged entity.

For better understanding, I am taking the case of HDFC Balanced fund which is one of the top performers in the erstwhile balanced category and a significant number of our investors own this fund. HDFC MF also had HDFC Prudence, which is also a well-known name, managed by Prashant Jain, though the risk profile is higher. In this instance, HDFC Balanced fund and Premier Multi-Cap fund were merged to form HDFC Hybrid Equity fund.  As part of the merger, the value of holdings in HDFC Balanced and the invested amount has been presented in a way that all gains accrued by the fund is lost (refer to the attached picture that displays the actual transactions for an investor). The amount obtained by moving out of the old fund is portrayed as the cost of new fund (Hybrid Equity). As a result, the investment amount in the portfolio is bumped up to that extent resulting in poor returns.

In this case the actual investment made by investor was Rs. 3,61,854 (accumulated 3230 units @ 112 Rs.) and the amount received during exit from old fund was Rs. 4,75,010 which is a gain of Rs. 1,13,156/-. However, the current transaction shows a loss of Rs. 9,575/-

The only sure thing about luck is that it will change - Bret Harte 

<Blog # PenguWIN 1059 – Mystery of Missing Returns ! >    

Is your Investment in Real Estate and Gold Safe?

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Warm Greetings from PenguWIN:

            The crux of this article is about the volatility in asset classes, physical and financial with specific reference to Real Estate, Gold and Equity investing, more specifically Equity MFs

Investors who started investing in equity funds since 2017 and seen the value go up and up, will probably be a little impatient, experiencing the 2000+ points correction in Sensex in the recent past and the associated high level of volatility. I make sure that I tell this to all our clients (at times more than once), that Equity funds are long-term investment products and needs to be looked at only for 5+ years, more the better. There may be a few who are lucky to enter the market when it was low, make money and exited before the fall. Even these people will fail if they try to replicate it for the second time. But, accepting the reality is always difficult.

Let me take couple of my favourite examples.

Let’s assume that a person buys an apartment in Adyar/Besant Nagar area. A 1000 sqft 2 BHK (basic price of 16,000/Sq. Ft.) will set him back by 2 crores, including registration, car park, corpus fund, club fees, EB, water, sewer etc. Once he takes possession of the apartment and moves in, within a couple of months, let’s say there is a slump in the RE (Real Estate) market and basic price drops to 15,000/- per Sq. ft. The investor will feel bad as his Networth has gone down by 10 Lakhs. On the other side, if the price increases to 18,000/- sq. ft, he feels happy that he has got a good deal, saving 20 Lakhs. Whether it is a question of 10L loss or 20L gain, there will no action of purchase/sale of the house as its notional and he has to live in the house. The value matters when he moves to a different place within or outside the country and decides to sell it or when he bequeaths the property to his children and they decide to sell it.

The same holds good when people buy gold jewellery or even coins. Gold has lost about 35% of its value since 2012 (35% is the consumer price Inflation) and the current price in INR is lower than the Sep/Oct 2012 price which was Rs. 3000/- plus. Several people have asked me this question – Is it a good time to buy gold? No one has asked me if it was time to sell gold. The worst thing is if its close friends or relatives and you tell them the facts of Gold (inflation hedge, intrinsic value and so on) which may be negative at that particular time, they feel that this guy is keen to drive Goddess Lakshmi away from our house.

Though many of the investors I encounter, have significant allocation to RE and Gold, they don’t get perturbed due to changes in price while even minor changes to stock markets (going down) is something that makes them anxious as they can easily relate numbers. So, even if the investor buys a fund for 1 lakh, that turns out to 1.25L in a year, the subsequent fall to say 1.1L is apparent as the mind relates to only the 1.25L figure, forgetting that the original investment of 1L.

Equity investing is for the long term (may not be that long as in the case of RE) and our patience will be tested by the market similar to RE and Gold, more severe at times. Some are unable to digest the volatility, especially people who have invested for short term that is just 1/2/3 years, going by the healthy returns of 2017. They tend to think that if 2017 has given 30% returns, then our investment should be able to fetch atleast 24% or 12% per year, in 2 years (fair assumption from their perspective). There are others who get excited by the returns that their friends and family members have made and move huge money to equity funds (Big Bang Investing), in a matter of few days, trying to make up for opportunity loss.

Whether 2018 or 2019 turns out to be as rewarding like 2017 (I will also be delighted to see my portfolio go up further), a time horizon of more than 5 years, higher the better, will definitely reward us with good returns and will continue to be the asset class that will provide the best returns.

People who hold less than 100% equity portfolios – Balanced Funds, Equity Savings, MIP can expect stability of returns in less than 5 years, approx. 3 to 4 years

What is the basis for my confidence? Equity market growth is a reflection of how the economy (GDP) does in the country, growth of companies in revenue and profitability, increase in consumption, increase in per capita income. The scepticism that prevailed in the market for the past few quarters is attributed to some of these indicators, not in green, while the markets were scaling new peaks. However, the Dec 2017, Q3, results have been positive and analysts expect that this momentum will continue in the coming quarters. Excluding the troubled Banking and Financial Services sector, Net Profit of a sample of 2043 companies rose to a six-quarter high of 27.5%, Net Sales by 11.5% YoY. We practice what we preach and your money is in safe hands.

We will only do with your money what we do with our won – Warren Buffett

 

<Blog # PenguWIN 1058 – Is your Investment in Real Estate and Gold Safe ! >