Longer holding period, more chance of alpha: Piyush Gupta, Director, Funds Research, CRISIL

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January 4, 2021 1:15 AM

The Reserve Bank of India (RBI) has proactively cut interest rates in the past couple of years to aid economic growth on the back of the slowdown and the impact of the pandemic.

With Sebi and the industry’s focus to penetrate the hinterland coupled with low yield from traditional fixed instruments, the share of B30 cities could rise.With Sebi and the industry’s focus to penetrate the hinterland coupled with low yield from traditional fixed instruments, the share of B30 cities could rise.

Large-cap funds have underperformed the benchmarks in the past three years even for a 10-year investment horizon primarily due to stock selection decisions coupled with the skewed performance of the underlying benchmark, says Piyush Gupta, director, Funds Research, CRISIL, in an interview to Saikat Neogi. Edited excerpts:

As inflows via SIP has stymied and equity mutual funds have reported outflow for the fifth consecutive month in November, are investors concerned about the performance of funds?
While there has been a decline in the outperformance of actively managed funds over the benchmark in the recent past, CRISIL analysis shows actively managed mid- and small-cap funds continue to deliver alpha over benchmark indices. In the past 10 years, these funds have on average delivered alpha close to 3% and 9%, respectively, for a seven-year investment horizon. However, large-cap funds have underperformed the benchmarks in the past three years even for a 10-year investment horizon. This is primarily due to stock selection decisions coupled with skewed performance of the underlying benchmark. The latter has been led by a few overweight stocks which funds are unable to replicate on account of regulated exposure caps and a limited stock universe.

Mid- and small-cap funds continued to generate alpha on account of the large investible universe and flexible investment mandate as compared with large caps. A longer holding period in the equity categories analysed increases the probability of generating alpha compared with the benchmark. Case in point, in the past 10 years, 100% of times, average performance of midcap funds for 7-year investment horizon is higher than benchmark in comparison to 76% of times for a one-year investment horizon.

Are more people in smaller towns looking at investing in mutual funds? What type of funds do they prefer to invest in?
As per data from Association of Mutual Funds in India (AMFI), B30 (beyond the top 30 or T30) cities contributed 23.7% to the mutual fund industry’s total assets under management (AUM) in September 2020 against 9.4% in March 2015. With Sebi and the industry’s focus to penetrate the hinterland coupled with low yield from traditional fixed instruments, the share of B30 cities could rise.

The break-up of money invested among T30 and B30 cities as per data disclosed by AMFI shows the latter had a higher share of money invested in equity-oriented mutual funds at 55% compared with 40% for T30 cities as of November 2020. The lower share of equity among T30 cities is also a factor of higher institutional investment from these cities which tend to be more debt-focused compared with individual investments.

In the current situation, what kind of duration should one look at for fixed income investments?
The Reserve Bank of India (RBI) has proactively cut interest rates in the past couple of years to aid economic growth on the back of the slowdown and the impact of the pandemic. CRISIL Research expects the 10-year yield at 6.2% at the end of the fiscal, up from 5.95% currently. The fundamental pressure of a large borrowing programme remains high, and continues to face upside risks from fiscal slippage. However, the RBI’s commitment to stay accommodative and provide liquidity to the system will cap the upside to yields. Based on the investor’s risk return profile and investment horizon, they can invest appropriately in debt mutual funds.

How should investors avoid concentration risk for higher long-term returns?
Concentration risk is the risk arising out of poor diversification in a portfolio and can arise from either over-exposure to a single security or over-exposure to a single sector or industry. Diversification helps mitigate this risk because when one security in the portfolio does not perform well, other securities that have low correlation with it tend to perform well, thus bringing a balance to the portfolio. Appropriate diversification is achieved if a portfolio has a reasonable number of securities which are evenly distributed and have a low correlation to each other. This is important because each security in the portfolio has unique risk factors and behaves differently across market phases.

How should investors use CRISIL Mutual Fund Ranking (CMFR) to select funds?
The CRISIL Mutual Fund Ranking (CMFR) is designed as an investment decision support tool for investors, both retail and institutional, to identify suitable investment products in the mutual fund space. It provides a single-point analysis of mutual funds, taking into consideration key parameters such as risk-adjusted returns, asset concentration, liquidity, and asset quality.

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