Parag Parikh Flexi Cap Fund: Is the Recent Underperformance a Concern?

It was not due to its asset size nearing a milestone of Rs 1.5 trillion, or due to its AMC launching a new fund offer.

The reason was the fund’s recent weak performance which made some investors uncomfortable because it has been highly regarded as a consistent performer.

Over the last few years, the fund was among the top performers in its category, having surpassed the benchmark and many of its peers by a notable margin.

In the last one year, however, the fund delivered negative returns of 2.6%. In comparison, the benchmark Nifty 500 – TRI index gained 3.3% and the category average stood at 6.1%.

The underperformance appears to be as a result of various factors listed below rather than a glitch in its investment philosophy:

1) Large Cap Bias

Parag Parikh Flexi Cap Fund maintains a large cap bias, investing at least 60-65% of its assets in the segment.

But since the performance of the large cap index has been fairly muted in the last one year or so amid FII selloff, large-cap-oriented funds too have delivered weak performance.

Its combined allocation to mid and small caps, a segment that has outperformed in the last one year, has been under 5-10%.

2) Overseas Investment Limit

A major contributor to Parag Parikh Flexi Cap Fund’s outperformance until a couple of years ago had been its strategic allocation to overseas equities. Earlier the fund invested around 30-35% of its assets in select global tech giants such as Facebook, Alphabet Inc, Microsoft, and Amazon.

While the fund still holds investment in these stocks, the allocation has come down to around 10-12% due to SEBI’s limit on overseas investment for domestic mutual funds.

3) Cautious Investment Approach

The fund follows a cautious investment approach by avoiding momentum driven investments. In addition, it prefers holding higher exposure to cash if attractive opportunities are limited.

Moreover, it follows a value-conscious, ‘buy-and-hold’ approach to benefit from the long-term potential of its high conviction holdings, even if it results in short term underperformance.

This strategy helps it manage downside risk more effectively during bearish market conditions. However, this also potentially means missing out on rallies during certain phases.

Key point to remember: Short term underperformance is normal

The recent weakness in Parag Parikh Flexi Cap Funds’s performance highlights something that I have always reiterated – past performance is not an indicator for future returns.

Today’s winners can be tomorrow’s duds; but the opposite holds true as well.

The performance of each stock/sector depends on various micro and macro-economic factors. Mutual funds managers invest in a diversified portfolio of stocks and sectors.

Over a period of time, growth may be conducive for select stocks/sectors and/or strategies, but not for others; though it’s likely to play out eventually.

Investors can ignore short-term underperformance due to market function as it’s the inherent nature of equity investment, but if a scheme consistently underperforms the benchmark and its category peers over various time periods, then you certainly need to track it closely.

In the case of Parag Parikh Flexi Cap Fund, its long-term investment philosophy remains intact. The fund’s long-term performance is encouraging, and it scores reasonably on risk-adjusted returns.

Value investing demands patience as it can register underperformance when the market is being driven by growth or momentum bets. As such, funds with a value-bias such as Parag Parikh Flexi Cap Fund too can witness extended underperformance when there is lack of value opportunities.

But a fund that follows prudent investment processes and has strong risk management techniques in place is often well-placed to deliver robust returns over the long run and recover from any setbacks.

So, the real danger for mutual-fund investors is often not temporary underperformance but abandoning a sound investment strategy at precisely the wrong time.

Conclusion

Equity investing is a long-term exercise, and periods of relative underperformance are inevitable even for successful funds. The recent numbers of a fund may deserve monitoring, but they do not, by themselves, provide a compelling reason to panic.

That said, this does not mean you should blindly hold a fund forever.

As an investor, you should watch for a sustained deterioration in long-term rolling returns compared to the benchmark and peers, major changes in portfolio quality, significant deviations from the fund’s stated philosophy, or a prolonged period in which the fund consistently fails to justify its risks.

If based on the above-mentioned parameters you conclude that your fund is consistently lagged, then it may be prudent to replace it with a better alternative.

Investors should evaluate the company’s fundamentals, corporate governance, and valuations of the stock as key factors when conducting due diligence before making investment decisions.

Happy investing.

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such. Learn more about our recommendation services here…

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