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February 17, 2000

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Devangshu Datta

Mutual funds on the go

Through the first half of fiscal 1999-2000, mutual fund watchers were confused by consistent discrepancies between the data released by the Association of Mutual Funds of India (AMFI) and the Securities Exchange Board of Regulations (SEBI). However, it was fairly clear that both sets of figures indicated a healthy growth trend. The difference is caused by the inclusion of offshore UTI schemes and venture capital in SEBI data, whereas AMFI only gives data pertaining to domestic raisings.

A look at the AMFI data for the first eight months of fiscal 1999-2000 shows a very strong move into mutuals. Between April-November 1999, the domestic mutual fund industry mobilised Rs 28,047 crore. With redemptions standing at Rs 16,397 crore, the net inflow was Rs 11,650 crore.

Last year the corresponding period saw Rs 15,189 inflow with an outflow of Rs 16,857 and a net redemption of Rs 1668 crore. Total assets under management in December 1998 were Rs 65,828 crore and that had risen to Rs 92,305 crore by November 1999. A total of 47 new domestic schemes have been launched in this fiscal up till December, compared to 23 new schemes in the corresponding period of 1998-99.

Now this is great for the long-term health of the market since it suggests that more and more paid-up members of the Indian middle class are sold on the concept of saving through equity. I presume that the tax break on equity mutuals was at least partially responsible. The other impetus would have come through a stellar market performance, which was good enough to have tempted many risk-averse investors to subscribe to the fund industry.

MF investors now have a total of 36 groups and more than 500 schemes to choose from. Amongst those, the 143 pure growth equity schemes have an effective investment universe of perhaps 1,500 listed companies to park their assets. Let's compare this situation to the US.

The American investor has more than 7,000 schemes to choose from. But the investible universe of stocks and bonds is much larger in the US and a lot of the funds are specialists in a big. The vibrant bond market in the US does not have an equivalent here. Other American mutuals are sector-specific schemes and a third lot are passive index investors. There is a fourth group of American mutuals, which invest abroad - there are plenty of them investing here in India, for instance.

So there is obviously plenty of room for further growth in both the number and possible types of schemes in the Indian mutual industry. But it is already among the best-developed sectors in emerging economies. There is another interesting difference between American and Indian mutual funds.

A surprising number of Indian equity mutual funds outperform the market indices. Very few American funds do and even fewer do it consistently. We could come up with a lot of explanations for this divergence in performance. The simplest is that the Indian stock markets are less efficient than the American environment. Of course, we could find plenty of anecdotal evidence of inefficiency especially amongst thinly-traded tech stocks on the NASDAQ. But it is probably true that US stock markets are more efficient on the whole.

Still the levels of out-performance have been extraordinary. If you look at straight forward net asset value (NAV) appreciation, 94 out of 143 all-equity schemes have beaten the Sensex between January-December 1999, and as many as 71 schemes have seen better than 100 per cent appreciation versus the Sensex return of 64 per cent. This means that more than half of the pure growth funds have beaten the market which is absolutely extraordinary.

Is this performance curve likely to continue? After all, if 57 per cent of growth funds consistently beat the market you could stick a pin into the list and back a winner. Well, consistency is difficult to judge since many of these funds are new.

Others have registered great performances by accepting the risk of being heavily overweight in one sector - usually IT or a combination of IT, Communication and Entertainment (ICE). Still others have dabbled in the highly murky waters of B Group stocks. This is a strategy, which will always fetch excess returns in bull markets but it is also a guarantee of great NAV erosion in a bear market.

Adjusting performances to assess them for greater risks is tough but a high degree of NAV volatility could be one theoretical benchmark. But a normal measure of volatility is the standard deviation from the mean. But a highly trending time series such as a constantly climbing NAV will also register a high standard deviation since this statistical measure is sign-neutral.

Does it mean that the mutual fund investor cannot mechanically apply mathematical measures to rank funds and reliably adjusting returns for risk? I'm afraid so. Mutual fund investors will have to fall back on the old methods of painstakingly scanning fund portfolios and tracking the NAV curve for violent swings and gyrations. The smoother the slope of the NAV, the easier the investor can sleep.

Another sophisticated measure is to track cash assets. A high level of cash assets suggests that the fund in question is afraid of either large-scale redemption, or apprehensive about imminent bearishness. In either case, the investor must ask why. A fund that fears redemption may be a fund in trouble but a fund that is geared for a downturn is probably taking a sensible step in the current market conditions.

Any investor who applies these principles will, of course, be working quite as hard on his portfolio as an investor who invests directly in equity. He does get several advantages - diversification, tax-breaks and the volumes of scale for modest outlays being the most obvious ones. A less obvious advantage is that the investment universe narrows down to about 150 funds from a possible equity universe of around 1,500 shares.

Devangshu Datta

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