How to compare the performance of mutual funds?

Introduction

The 2020 has been the shocker year for the world due to sudden outbreak of deadly disease COVID-19. We all have been busy in saving our lives and we are still doing everything possible to not get caught by this disease. The jitters it sent to the world including financial sector cannot be ignored. While we were thinking of saving our lives, mutual fund managers were thinking how to save and grow investors’ money. Mutual fund managers were doing more than they could by analyzing the trends and asking investors to not get panic and stay put. But as the panic set in mutual funds saw a lot of redemption in the month of March and April immediately after the Covid-19 induced nationwide lockdown.

When we are stepping into 2021 following an unprecedented year 2020, indices are trading at an all-time high and mutual funds that have their portfolio allotted in equities have made huge return for investors. Specifically, the pharma sector in thematic category of mutual funds has given the highest returns. Surprisingly Small Cap funds have also outperformed the indices.

The assets under management of mutual funds in India has grown four times in the span of last 10 years.

What did 2020 bring for mutual funds?

India’s equities market experienced the worst sell-off in the month of March 2020 prompted by the coronavirus pandemic. However, sentiments of investors became stable in October and most of their losses were recovered by the month of November. An exuberance was shown by Mutual funds in the month of January and February, but it was followed by a sharp redemption in April 2020 on account of Covid-19. Investors redeemed a net of ₹ 12,917 crore from equity mutual funds in the month of November in order to take advantage of the market rally since April 2020 and book the profits from their respective investments. This shows that whenever market is in downward direction, it scares the investors. Investors started to question about the sustainability of their investments and pulled out their money. This scenario concluded that returns from equities are not linear and there will be a certain kind of lumpiness present in equity class of assets in times of global shocks. However, some who believed the market corrections were temporary sensed an opportunity and started investing during the huge market correction and made significant profits. Some mutual funds who knew how to be ahead of the curve made it to the top performing mutual funds of this unprecedented year 2020. The major highlights of mutual fund industry in 2021 are expected to be Small Cap funds, Sectoral funds and Thematic funds. Let us look at few of them in detail:

Small cap funds

Regulatory body Securities and Exchange Board of India (SEBI) mandates Small Cap funds to invest at least 80% of the total equity assets in Small Cap stocks. Small Cap companies are the companies whose rank lies between 251 to 500 in the NIFTY index. Small Cap companies have a market capitalization of less than ₹ 5,000 crores. Mutual fund schemes that invest at least 80% of the total assets in small cap stocks are known as Small Cap funds. In 2020, the below Small Cap funds have outperformed their benchmark indices in terms of 1-year returns.

As per the analysts’ opinion, in 2021, Small Cap stocks are expected to outperform their peers. Mutual fund schemes that have invested heavily in these stocks are expected to generate handsome returns to the investors.

Here are the some of the Small Cap funds that are expected to perform well in 2021

If you want to know more about the Small Cap funds, please visit our blog by clicking this link https://sipfund.com/blog/Small-Cap-Funds-Can-you-handle-them.html

Sectoral and thematic funds

As the name suggests, sectoral funds invest in different sectors. They invest in sectors like pharma, banking, information technology, hospitality, construction, FMCG, real estate, etc. As per the SEBI guidelines, sectoral funds are supposed to invest a minimum of 80% of their assets in the specified sectors and remaining 20% can be invested in other debt or hybrid securities. These funds allow investors to take advantage by investing in best performing sectors. Pharma sector, which was underperforming in the past few years, has been provided an impetus from the Government’s schemes to boost the health care sector following the global pandemic. The investors feel confident while investing in pharma industry as it is backed by government of India.

Thematic funds invest in companies of various sectors having a common theme. Thematic fund houses first define their theme and then look for companies who are following the same theme. It means that if investors are ESG conscious then they will invest in those companies which are rated highly on ESG parameters.

Below are the list sectoral/thematic funds that have performed extremely well in 2020 in terms of 1-year returns.

It can make sense as pharma sector, which was underperforming in the past few years, has been provided an impetus from the Government’s schemes to boost the health care sector following the global pandemic. The investors feel confident while investing in pharma industry as it is backed by government of India. DSP Health Care Fund has given a yearly return of 77%. Expense ratio of the fund is at 0.81 percent and fund's top portfolio constituents include stocks such as Cipla, Dr. Reddy's, IPCA. However, investors should note that sectoral funds are risky and cyclical in nature. Those who have high risk appetite should consider investing in these types of mutual funds. To know more about the Sectoral, Thematic and ESG funds, please visit our blogs by clicking the below links:

Here are the some of the Sectoral & Thematic funds that are expected to perform well in 2021

Having talked about the mutual fund performance and new trends of 2020, let us now look at the changes brought by SEBI in 2020:

Factors to keep in mind before zero in on mutual funds in 2021.

Amendments from SEBI

Securities and Exchange Board of India (SEBI) keeps making amendments from time to time to keep the market discipline intact and investors’ interests are secured. Some of the new rules from SEBI will be implemented in 2021 onwards which are to be taken into consideration by the investors. The rules are mentioned below:

(1) SEBI mandated the Multi Cap equity mutual funds to have 75% of their asset allocations in equity and equity related instruments from 1st January onwards. This limit is revised from earlier 65%. Additionally, Multi Cap mutual fund schemes also must invest a minimum of 25% of the portfolio each in Large Cap, Mid Cap and Small Cap companies.

(2) SEBI made changes to risk-o-meter and the risk-o-meter will be having six categories. The six categories are: i) Low Risk ii) Low to Moderate Risk iii) Moderate Risk iv) Moderately High-Risk v) High Risk and vi) Very High Risk. Debt mutual funds will be evaluated based on interest rate, credit and liquidity. On the other hand, Equity mutual funds will be evaluated based on market cap, volatility and impact cost. The new risk-o-meter has come into force from 1st January 2021.

(3) The third rule is related to growth and dividend option. In the growth option profits made by the fund are reinvested back into the mutual fund scheme but the profit is distributed to unitholders on a quarterly, half-yearly or annual basis as "dividends” under dividend options. To avoid confusion for investors, SEBI has thought of renaming them as "income distribution cum capital withdrawal" option.

(4) SEBI has mandated mutual fund schemes to allot NAV on units when the amount is realized from 1st February 2021. Liquid and overnight funds are exceptions in this case.

(5) Flexi Cap Fund: A new category of mutual funds has been introduced in November 2020. Mutual funds are supposed to invest at least 65% of the total corpus in equities and equity-related instruments, across Large, Mid and Small Cap stocks.

To know more about the new rules or amendments by SEBI, please visit our blogs by clicking the below links:

Let us now look at some more points which can be beneficial while stepping into mutual fund investing in 2021.

When investors put their money into different asset classes say for 3 years and if at the end of 2nd year, they do not see their wealth going up, the panic sets in. Investors with a heavy heart redeem their money early. Immediately when investors pulled out the money, market reached a certain height and then investors are left with regrets only. The point made here is simple that investors must have faith when markets are low.

The role of Atmanirbhar packages by government in providing impetus to Mid Cap and Small Caps has been appreciated by the industry experts.

The central government has been emphasizing a lot to make India an Atmanirbhar nation. Being Atmanirbhar means that India should be self-sufficient in producing much of the goods and it should minimize the dependence on imports wherever it can. It is important to note that being an Atmanirbhar does not mean close economy.

RBI in tandem with Government has been providing a lot of liquidity in the hands of Small and Medium Cap companies through lowering interest rates, extending GST filing dates, providing subsidies wherever possible. Government is being flexible on interest and payment defaults of Small and Mid-Cap companies in the year 2020 as these are worst hit due to Covid-19. Authorities are of the opinion that once the economy settles, companies would be in better position to pay back what they owe and hence these companies can operate further confidently without worrying about legal actions for at least 1 year.

These measures have given an impetus to the Small and Mid-Cap companies. Investors are also confident now as government’s focus is more on making Small and Mid-Cap companies profitable. This is one of the biggest reasons of immediate upward movement in Small and Mid-Cap stocks. After lagging for three consecutive years, these stocks started to outperform Large Cap stocks.

Market are trading at all time high with Sensex at 48400 mark and Nifty in 14200 range. However, when markets reach such a high level then there is narrow scope to go up further therefore investors should not get overwhelmed from these short-term positive sentiments of markets. They should keep their portfolio balanced by investing in different mutual fund categories and be patient to reap the return benefits because investors who were patient in 2020 earned higher profits. They did not subsume to knee-jerk reactions and stay put when majority of investors were pulling out money from investors. A balanced approach, reliable fund manager and patience are the key features that are prerequisite for earning good returns in mutual funds.

Given below is the list of the top performing mutual fund schemes from various categories that we expect to do well in 2021 and recommend to our investors:

Conclusion

Mutual funds are an ideal tool for investing if you want to take advantage of compounding provided you have patience and tendency of not getting overwhelmed by the knee-jerk reactions. Above list of funds are expected to perform better than benchmark in 2021. It is suggested to stay invested once you chose your scheme to get maximum gains. As per Morningstar biannual Global Investor Experience report on disclosure, India mutual funds along with US mutual fund industry received “top” grades due to their investor friendly and transparent disclosure practices. India earns a top grade for its portfolio management, simplified prospectus, and monthly disclosure of portfolios. Indian mutual fund industry is also working to improve the level of details required by the investors with regards to risk and returns. It is therefore a proud moment for India’ mutual fund industry as they are able to earn the confidence of investors and make the investors to fulfil their financial goals by investing in mutual funds.

Happy Investing!