In its purest sense, alpha is the measure of a fund?s risk-adjusted return relative to the market. It measures the difference between a fund?s actual return and its expected performance, given its level of risk as measured by beta.
A positive alpha indicates that the fund has performed better than its beta would predict. So an alpha of 10 would mean that the fund outperformed the predicted beta return by 10%. Naturally, investors would want to chase high-alpha funds. But alpha has its quirks. While alpha can be directly used to measure the value added (or subtracted) by a fund?s manager, it depends on the beta. It goes by the assumption that market risk, as measured by beta, is the only risk measure necessary. So the drawbacks that apply to beta, apply to alpha.
The beta is a measure of a fund?s sensitivity to market movements. A beta value of 1 indicates that the fund moves in exactly the same direction and pace as the market. A beta of more than 1 implies that the fund is more volatile than the market while a beta of less than 1 implies lesser volatility.
But a fund?s beta is not meaningful if its R-squared is too low. R-squared varies between 0 and 1, with an R-squared value of 1 indicating perfect correlation with the index. The lower the R-squared-the less the correlation between the fund and its index, which implies that the alpha and beta are less meaningful. A high R-squared lends credibility to the accuracy of the fund?s alpha and beta.
Here we listed the top five alpha funds along with their analysis. Some may make a good fit in your portfolio.
Magnum Contra: on a fast track
Magnum Contra has consistently managed to stay ahead of the curve. The fund outperformed the category in every quarter since the start of 2003. When the market rises, this one rises higher than the average peer and when the market slips, it tends to fall much less than the category as well.
It emerged as the second and third best fund in 2004 and 2005 and was pretty impressive last year too. But don?t get misled by the name. When it was true to its calling, its stock picks and sector moves made it an awfully bold choice. But somewhere down the road it shed its contrarian image. But fans of this strategy should not despair. The fund still displays flashes of it. The fund?s moderate stance in technology and financial services, is a case in point. Or its significant holding of metal stocks. The fund manager maintained a status quo on auto holdings when the tide turned against the sector after the first interest rate hike in December 2006. And only in May this year was there refreshed activity here. But the fund played it safe by sticking to Tata Motors and Maruti Udyog. However, we don?t see it as a sign that it has run out of gas. The fund has struck a fine balance between riding on consensus sectors and taking contrarian bets. The end product is a blended portfolio of growth and value stocks. While still holding on to its multi-cap orientation, the portfolio has expanded from 31 odd scrips to 57. As long as the fund manager finds value in the stocks, he continues to hold them. Given its dynamic asset management strategy and robust track record, we think that this is a topnotch pick. Despite the fact that its contrarian aspirations have been tempered down, finding a place for this fund in one?s portfolio would be a worthwhile effort.
Magnum Global: capricious performer
With sporadic bursts of performance, it?s hard to know what to do with this fund.
From a fairly dismal track record, it was the best performer in 2004 and the second best in 2005. Last year too it had a great run. From a large-cap bias, it aggressively turned to investing invest in mid- and small-cap stocks in 2004. The move paid rich dividends which was visible in the performance. During the three-year period from 2004 to 2006, the fund generated better returns as compared to its category in every quarter. The fund?s strength has been its ability to pick trends, invest aggressively and ride through the momentum to make huge gains. So, while other fund managers balked at dabbling in real estate plays during their high rise in 2006, this one caught on to Ansal Properties and Infrastructure aggressively. And it was handsomely rewarded. Some of its other profitable picks include Dishman Pharmaceuticals, Sintex Industries, India Cements, Infotech Enterprises and Jai Prakash Associates.
This year, it is struggling to live up to its performance standards. Its five-year annualised returns of 64.45% rank it way ahead of the average of 49.94%. But its year-to-date, one-month, three-month and one-year returns are below the category average (as on October 22). Its earlier focus of 30-35 stocks well spread across all holdings has given way to 70, none of which account for more than 5%. This could be the fall-out of its large asset base, which has crossed Rs 1,700 crore. With the recent increased diversification, low concentration levels and huge asset base, this mid-cap fund is in uncharted territory. Though we still potential investors may want to wait for signs of improvement.
Magnum Multiplier Plus: risky proposition
Like wine, it has matured with age.
Magnum Multiplier Plus was amongst the most criticised in the 2000-2001 meltdown. After delivering an astounding 218.91% in 1999, the fund lost (-) 50.31% in 2000 and followed it up with another disastrous (-) 41.58% loss in 2001. The culprit for this abysmal performance was lack of ample diversification and highly concentrated bets taken in the IT space. But the fund managed to pull out of this trench.
A look at the most recent bearish quarters? ending June 2006 (April-June) and March 2007 (January-March) shows that the fund has learnt to manage the downside better than before, and has lost only as much as the category average. This has been done by reverting to the time tested strategy of diversifying holdings. As a result, the fund has managed to progressively deliver a much better risk- adjusted return compared to the average peer. With assets evenly divided between large and mid caps and a small exposure to small caps, the fund steers clear of a capitalisation bias.
But old habits die hard. It had a rather high 26% allocation to the basic-engineering and another 9.67% in the construction space (as on July 31). Now construction is 17.36% and basic-engineering 16.34% (September 30). Its IT sector exposure went down to 2.05% (July 31) to rise to 8.05% (September 30). The fund will sit well with investors who are willing to take on slightly higher risk than the category average.
UTI Infrastructure: young turk
In just three years of its existence, this fund has more than proven the merit of its theme.
The first infrastructure fund to be launched, it was a classic example of the early bird getting the worm. It found a spot in the top quartile of the category in 2005, generating 57% returns and outdoing the average peer by a margin of more than 10%. The next year it leapt to the topmost slot with returns of 61.48%. This year, despite a few bumps in the road in the first quarter, when real estate and cement corrected sharply, the fund is going great guns. Its year-to-date returns (as on October 22, 2007) were 39.33%, sharply ahead of the category average of 25.98%. When you are catapulted to the No 1 slot, you can?t help but get attention. And investors have flocked to this offering in droves. Its asset size has risen from under Rs 60 crore (April 2004) to over Rs 1,400 crore at present.
Though spread across stocks of different market caps, of late it has developed a bias for large caps. At the end of September 2007, large caps accounted for 61% of its assets. Despite being a thematic fund, it has a reasonably diversified portfolio of 40-45 stocks. Capital goods, construction, energy, technology and metals are the sectors that dominate the portfolio.
A worthy selection if you want to bet on the capital expenditure wave.
Sundaram Select Midcap: changing tack
The fund is known for its astute stock picking. The earlier fund manager, Anoop Bhaskar, dabbled in construction companies (Gammon India, IVRCL Infrastructures, Hindustan Construction) when most investors would not touch them with a bargepole. Unitech entered the portfolio later (2005). That was also the year he bought Emami, which delivered impressively. Kohinoor Foods, Lakshmi Machine Works and Thermax were some other good picks.
Besides good stock picking, the timing could not have been better. Launched in July 2002, mid-caps started gaining momentum in 2003. The fund ended that year as the third-best equity fund with returns of 157.73%. As the mid-caps slowed, this fund dipped slightly in performance only to shoot up to the second-best spot in 2006 with 60.77% returns.
Naturally, huge investor interest followed taking the assets from Rs 500 crore (January 2006) to Rs 2,203 crore (May 2007). Recently, there has been a slight dip in assets to Rs 2,116.66 (September 2007). There were two much talked about aspects of this fund, both of which are changing. It was noted for its extremely diversified portfolio. From around 60-odd stocks late 2004, it swelled to a 112-stock pack by April 2007. But the number of stocks has been diminishing and it touched 82 in September this year.
And, it often had the highest cash holdings amongst its peers; there were times when it touched 32% of its portfolio. But in May 2007, it reduced it to 5% and since then it has hovered around 3.26%. The current move towards lesser stocks and a lowering of the cash holding should spell good news because it speaks of a more concentrated portfolio whose returns will not be diluted. But, the fund is facing some heat on the performance front.
This year, its quarterly returns have not beaten the category average and its year-to-date, one-month, three-month and one-year returns are lower too. Despite the current statistics, this one is a good bet in the mid-cap space.
Reliance Growth: size no bar
Though last year it witnessed a dip in the performance rankings, its track record prior to that was enviable. In this regard, it is worth momentarily comparing it with Sundaram Select Midcap, which topped the performance chart in 2006.
But Sundaram BNP Paribas Select Midcap is seeing its assets dip while this fund has seen them rise from Rs 3,776 crore (May 2007) to 4,617.19 (September 2007), keeping it intact in its position as the largest mid-cap fund. With mid-cap funds, size is an issue. The bigger the size, the more restricting it is for the fund manager to take aggressive positions in small stocks. This fund manager must be commended for his handling of the fund. He has not taken diversification to the extreme by flooding the portfolios with stocks and neither has he held phenomenally high cash positions.
The fund has an ability to adapt to market movements. In a rapid bull run, it will look at growth stocks, not value. In a slower market, it will change its stance. This flexibility is extended even in the preference for market cap. If the need be, Growth will increase its large-caps substantially. Currently, large-caps are at around 37%. Reliance Growth is basically a pro-active fund that regularly churns out fresh ideas. The fund does not churn its portfolio rapidly and adheres to a buy-and-hold strategy as far as possible. Though last year it outperformed the category average, it was not a top-quartile performer. This year has been impressive.
Till date, the huge asset size has not hindered returns. But it remains to be seen whether it can continue to outperform.
?The author is CEO, Value Research
