When the markets are booming, can mutual funds be far behind? Certainly not. But look closely, and you can see that there are funds and funds.

A rising tide lifts all boats, but some boats have risen higher, thanks to canny sectoral choices by t heir helmsmen.

Which is why even though the Sensex has risen 30 per cent and the Nifty 24 per cent since the start of the fiscal year (April 2003), the best-performing mutual funds have done more than twice as well. Their returns are in excess of 60 per cent.

The secret of their outperformance can be described simply: mid-caps. This is apparent from the fact that diversified funds have done better than mainline index funds.

Supporting evidence comes from the stellar performance of mid-cap index funds - like the Nifty Junior BeES exchange-traded fund, for example - which topped the overall equity-funds table.

The broader indices - the BSE 100, the BSE 200 and the BSE 500 - have all given returns close to 40 per cent during the rally.

"The markets have been on an upswing and funds have been prudent to position themselves with the right exposure to the right sectors," says S Nagnath, CIO of DSP Merrill Lynch mutual fund.

"The breadth of the rally apart, the choice of allocation of sectors ensures better performance," he adds.

With interest rates at historical lows, traditional investment classes such as bank fixed deposits and other small saving instruments have lost their charms.

Investors are thus increasingly looking at equity funds as saviours, say analysts. And going by evidence for the current market rally, they have been well served too.

Equity funds have risen like a phoenix from the ashes of 2001, beating all comers in the returns stakes for fiscal FY04 so far.

The annualised category-wise returns of mutual funds tell a story. While equity diversified funds as a category clocked annualised returns of 48.56 per cent, equity - ELSS schemes registered 42.84 per cent and equity index funds 36.59 per cent.

Among sectoral funds, pharma funds topped the charts with an average return of 30.80 per cent, followed by MNC sector funds at 27.20 per cent.

Compare this to the other fund categories. Balanced funds performed reasonably well, with average returns of 32.47 per cent.

Gilt, income, MIP (monthly income plans) and income fund categories were lagging way behind at 14.02 per cent, 12.01 per cent. 8.77 per cent and 6.40 per cent, respectively.

Analysts are of the view that markets are fundamentally strong, for the time being at least. They point to good corporate performances, ever-increasing FII inflows, low interest rates, the gathering pace of privatisation and a good monsoon as the pillars on which the markets have run up.

The moot point, though, is whether fund managers actually did a good job or merely reaped the harvest from heavy liquidity inflows.

"We have a diversified portfolio for our equity funds. The rally this time has been broad-based and this has helped us give good returns," says Rajat Jain, CIO of Principal Mutual Fund.

Most fund managers did not really have to churn portfolios to generate returns. "We, at Principal have not done any major portfolio churning during the period. We have increased our positions in cyclicals, but apart from that nothing dramatic has taken place in our portfolio," says Jain.

Another equity fund manager with a leading domestic mutual fund echoed the sentiment noting that the portfolio turnover has not been high this time.

"The rally has encompassed almost all the sectors, which has helped equity funds perform better during the bull market," says he. A look at the portfolios of the leading performers during the period stands testimony.

Take for example, Birla Equity Plan, one of the best performing equity funds during the period. While the fund had 20.94 per cent exposure to the banking sector in March, by the end of July it was practically unchanged at 20.13 per cent.

However, the fund did pare its holdings in the IT sector from 17.30 per cent in March to 10.71 per cent in July. And for good reason.

In fact, most equity funds have cut down on their IT holdings during the period. Among leading BSE indices, the BSE IT Index (down 10.03 per cent) is the only one which has declined during the five-month period as worries about an appreciating rupee and pricing pressures weighed heavily on IT sector fundamentals.

The ones who bet on the IT sector were the worst performers of the lot with most of them giving meagre single-digit returns. But there are funds which have not been averse to churning their portfolios.

In the case of Reliance Growth Fund (67.57 per cent), a 13.75 per cent stake in the banking sector in March went up with rising prices to 20.02 per cent, while the share in IT sector has been cut almost 50 per cent from 11.39 per cent in March to 6.42 per cent in their latest portfolio.

Mid-table Prudential ICICI Growth Fund, which gave a return of 40.01 per cent, also did a fair amount of adjustment to its portfolio.

The fund had a 19 per cent exposure to auto scrips in March, which was its top holding, followed by 16.85 per cent in the banking sector and 11.70 per cent in IT.

By the end of July, the fund had surprisingly cut down on its banking exposure to 12.99 per cent.

Auto holdings were also reduced to 13.49 per cent, while the oil and gas sector got top billing at 13.78 per cent as the fund tried to join the divestment bandwagon in HPCL and BPCL.

It is clear that even while most fund managers have benefited from a fairly diverse exposure to different sectors, the top performers were aided by their bias towards banking, pharma and oil and gas. Some threw in a bit of steel and auto too.

"Changes in portfolios depend on the investment strategies adopted by different fund managers and their approach to managing money," says Nagnath.

So far, so good. But should fund investors be encashing some of their gains or sit tight to let them grow further?

Some analysts are predicting the Sensex to surge to 4,800 by the end of the fiscal, which means the equity party is all set to continue. Other fund managers sound a word of caution.

According to one, even though things definitely look good over the long-term, the short-term outlook is uncertain with the markets already running at a frenetic pace.

"Our long-term view on the markets is positive and we expect equity funds to do well too," says Nagnath. "The markets have the momentum and are likely to go still higher. But there could be a period of consolidation in the short-term before the upsurge continues," Nagnath adds.

For cautious investors, this could be time to book some profits.