Hope this New Year 2017 brings in Happiness and Prosperity to all of us.
Investments in Mutual Funds have been increasing continuously due to money coming in from retail investors. The last quarter (Oct-Dec ’16) has seen significant participation, touching all-time highs (Domestic Institutional Investors includes MFs, LIC, Provident Fund).
2 key reasons why the Retail Investors participation have increased in Equity are:
- Increasing awareness level of investors that Equities have the potential to deliver the maximum returns (among all asset classes) and Mutual Funds offer the simplest and effective way towards wealth building. Even retail investors from smaller cities and towns have started participating. SIP (Systematic Investment Plan) has become the ‘buzzword’
- The fall of Real Estate, Gold and recently, the Fixed Deposit returns have greatly reduced the charm in these asset classes, resulting in exposure to Equity MFs, a necessity
Another interesting trend is the volatility of the markets influenced by FIIs (Foreign Institutional Investors). The DII flows have been on the rise (See Chart 1) and able to counter the FII outflows, lending stability to markets.
The volatility (positive and negative swings) of the Sensex and Nifty influences the psyche of investors, inducing worry and panic that they have lost wealth when the Sensex turns red – greater the fall, greater the anxiety.
Chart 2 shows the returns of Sensex and Nifty over 1, 3 and 5 years along with Equity MFs Category average (Large and Multicap Funds). The difference or delta between the Indices and the Fund returns (Active MFs) is referred as Alpha, which is generated by the Fund.
The following illustrations demonstrate how a fund manager can generate Alpha over Sensex (Sensex-Stocks-and-Weights.jpg) is discussed below:
- Among the 30 stocks in the Sensex, people who have some exposure to economy and business trends would know that Bharti Airtel has been going through a phase of dwindling margins and high capex investments, that has hit the entire Telecom segment. Another example is Tata Steel’s acquisition of Corus, UK which became a disaster. If the fund manager eliminates or doesn’t investment in them, the returns would be higher or Alpha is generated (Large Cap Equity Fund with Sensex as Benchmark).
- Stocks like HDFC Bank, Asian Paints, Maruti Suzuki have been beating the Sensex consistently and increasing the weightage of these stocks in the fund portfolio will result in increased Alpha.
- Most of the Large Cap Funds take exposure to a small proportion of stocks that offer high potential, other than stocks present in Sensex and Nifty thereby creating Alpha
When the Indices Fall or Increase by a significant level, the value of the funds too fall or increase. But the magnitude/percentage of fall or increase would be different as these are actively managed funds which have a different stock composition and weightage.
Chart 3 shows the returns of couple of top funds in Large and Multi-cap category where the Alpha is the highest between the Index and Fund.
There is a category of funds that mirrors the Indices which are referred as Index Funds. These funds are passively managed and replicate the stocks in the Index with the same weightage and charges low expenses. The Index investing is popular in developed countries like US and several European countries (Efficient Markets) where fund manager generating Apha is very difficult (Active funds have to make up for the additional expenses incurred, which is higher than Index Funds).
India does have quite a number of Index Funds. But we have a long way to go before Index Funds become popular as the Alpha generated by Active MFs is quite high, at present (Inefficient Market)
A very happy Pongal & Sankranti wishes to all of you! Iniya Pongal Vazhthukkal!
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