Quarterly review – changes to recommendations in Prime Funds & Prime ETFs

Prime Funds narrows the choice of the thousands of funds out there in the market into a list of 50-60 funds that you can pick from to invest. This quarter we have made some additions to gain from the renewed strength that the equity market is exhibiting, the recession fears in the US notwithstanding. There are some additions in the debt space as well, as yields moved up. We have removed some funds that were bigger laggards and are observing the slip in performance in a few others. If you are new to Prime Funds, we urge you to read the contents in the table below to know how to use them to your advantage. Otherwise, use the Table of Contents below to navigate to the section you are keen on.

Equity funds

The equity markets had yet another tepid quarter with intermittent corrections. But the quarter ending September 2022 did manage a decent 6% gain, thanks to a strong comeback in consumer and pharma stocks in September. Besides, the strong rally in capital goods and engineering also helped sector/thematic funds in this space. Sector/theme based Prime Funds from this space therefore gained well. 
The changes we made this quarter are discussed below. We also alert you to some of the poor performers – you need not act on these until we explicitly give a call.

Equity Moderate – Active

Funds in this category had a tough time primarily because of the underperformance of the IT sector. Most large-cap and flexi cap funds have equal or overweight exposure to IT, given that the sector commands a sizeable weight in all large-cap indices, next to the banking & financial sector. Hence, it did not come as a surprise when we saw a few of our funds in this segment underperforming. 

However, we had to take a decision on funds that saw more pronounced underperformance or where the deterioration was visible from previous quarters. Axis Bluechip was one such fund. 

Axis Bluechip’s underperformance can be traced to hits in IT stocks such as Infosys and TCS (although exposure has reduced) or financial stocks such as Bajaj Finance (relief rally in the past 3 months notwithstanding, the stock saw a volatile year on the back of elevated valuations) and HDFC Bank. The fund’s focused portfolio approach impacted performance. 

While we took note of this in our last quarter review, we find the margin of underperformance to be increasingly high. The proportion of its outperformance over the index on a rolling 1-year return basis also deteriorated to 45%. While funds such as Mirae Asset Largecap are also struggling, their outperformance still stood at a decent 61%. 

We are adopting a hold strategy on Axis Bluechip. You can stop any fresh SIP investments in the fund and hold existing investments for now. 

We have instead added ICICI Pru Value Discovery. This is not an early pick, since value as a strategy has been gaining ground post the 2020 market correction and the fund has been delivering well for a while now. Nevertheless, we do think there is room for value to deliver currently as the undervalued and contrarian sectors such as healthcare, energy, and, importantly, pockets of undervalued financial stocks are best played through such funds. The fund can also provide some hedge in this volatile market. 

ICICI Pru Value Discovery fund has delivered positive returns in the past 1 year when large-cap indices have struggled to remain in the green. While we have 2 other contra funds in our list, note these points: one, the contra funds in our list have some exposure to growth stocks and are therefore not pure value. Two, ICICI Pru Value Discovery has only about a third (portfolio weight) overlap with each of those funds, thus complementing them. 

That said, it is better not to go overboard on value with your portfolio as value is known to go through long periods of underperformance. ICICI Pru Value Discovery for instance has just surpassed its benchmark over a 5-year period, having underperformed for over 2 years. 

Overall, in the Equity Moderate category, we find an increasing need for you to hold market-cap weighted index funds to ensure that your portfolio stays with the market. Select large and flexicap funds do continue to beat indices – but that they are unable to do so on a steady state points to the fact that index investing is gaining ground. Having some part of your large cap/moderate risk portfolio in large-cap index funds may become necessary to keep returns in tune with the market. You will find passive index funds in Prime Funds, which we have classified separately.

Equity Aggressive – Active

We added Nippon India Multicap in this category. This multi-cap fund can help you take adequate exposure to mid and small-cap segments if you do not want the direct risks from the latter segments. Active sector calls and playing a mix of growth and value has ensured that this fund has steadily climbed the ranks in performance. Earlier called Reliance Equity Opportunities, this fund has picked up in recent times, playing both the secular consumer spending story as well as the more cyclical story from capex spending in the country. The fund has comfortably managed to beat its peers and benchmark in the past few quarters and also competes well with funds from the large and midcap category. 

Please note that the fund’s rating stands at ‘2’. This low rating is because the fund has limited record as a multi-cap fund (a new category under SEBI) and was in a different category with more bias for large caps earlier. On the other hand, some of its peers were already holding higher exposure of mid and small-cap stocks before the new category came into being and therefore sported higher returns. In short, the rating is more backward looking and you may ignore it until a track record is built. Since this fund’s performance pick up is relatively recent, ensure that it is not core of your portfolio, if you decide to hold it. 

We have removed Invesco India Midcap. You can continue to hold the fund and just stop fresh investments and SIPs for now. While we always found the fund’s portfolio to be a sound one, the market moves in 2022 has seen many midcap funds struggling to beat the index. The fund’s outperformance on a rolling 1-year return basis dipped from 62% as of June 2022 to 55% as of September 2022. After our experience with DSP Midcap, we do think that midcap funds that lose out too long can find the comeback quite hard as peers take over quickly. 

Hence, while the underperformance of Invesco India Midcap is not bad at all, we are being a bit cautious on this front and also since there are sufficient mid and small caps available in Prime Funds to play the risky segment. We will watch performance and if there is a bounce back, we may reinstate it as it is a fund that contains downsides well. 

Overall, only a handful of midcap funds managed to beat their benchmarks in recent months, even as small caps did a far better job. This can be partly attributed to more selling pressure in the midcap space (possible FPI pull out) than it the small-cap space over the last 2 quarters. Hence, you will need to be patient and continue your SIPs in this segment. 

In the Equity Aggressive – Active category, we would like to highlight the following observations. No action is needed on these points:

• We have moved PGIM Flexicap from the Equity Moderate category to Equity Aggressive, in line with the higher mid-cap exposure it sports. Make sure you do not have high weight to this fund if you are a low to moderate risk investor. The fund continues to sport good performance.
• We are taking note of the sharp underperformance of UTI Flexicap in the past 3 months as the result of the rout in IT stocks. It holds at least 4 percentage points more in IT sector, compared with Flexicap peers. As a result, the hit was harder. Besides, exposure to stocks as Bajaj Finance and HDFC Bank had pulled down performance earlier this year. We are watching the fund’s performance and are not too concerned about its ability to bounce back, given the sound portfolio. The fund still scores over peers on a rolling 1-year and 3-year metrics. We will alert you if our thesis does not hold. You can continue investments in the fund. 
• We are taking note of some underperformance in the seemingly invincible Mirae Asset Emerging Bluechip. This, too, can be attributed to the mid-cap rout (more than small cap), perhaps triggered by profit booking. In general, many funds in this category have struggled to beat the benchmark Nifty LargeMid 250. This is one of the reasons why we have introduced an index fund mirroring this index. We will watch for performance closely. No action is needed at present.

Equity Aggressive – Passive

Equity – Tax Saver

In this review, we have added Parag Parikh Tax Saver. This fund has just crossed the 3-year minimum cut-off we maintain in order to rate equity funds. While its track record is brief, the fund has shown the capacity to deliver above-average returns. The fund beats the Nifty 500 index about 75% of the time on a rolling 1-year return basis over the past 4-year period. This is far better than even older ELSS funds. 3-year returns have so far held above the Nifty 500 index. This apart, the fund is adept at containing downsides and sports below-average volatility.

This comes from its strategy of maintaining higher cash positions when required. The fund has gone even up to 20% in cash in earlier months, when markets were uncertain or overheated. The fund follows a stock-specific value-based approach and maintains a compact portfolio with top stocks having heavier weights. In its strategy, the fund differs from most other ELSS funds which tend to be far more aggressive.

However, Parag Parikh Tax Saver does have a marked portfolio overlap with Parag Parikh Flexicap. If you hold the latter fund in your portfolio, it would be better to go with the other Prime Funds from the Tax Saver category.

Hybrid funds

We have made no changes in our hybrid fund recommendations. However, we would like to make some observations about aggressive hybrid funds, which we include in the Hybrid – Moderate Prime Funds category.

Hybrid – Moderate

This category comprises funds from the aggressive hybrid category, and those balanced advantage funds that are not too conservative in their hedging strategies. Both categories have seen quite a few new funds and these funds have not really seen a low-returning market phase or prolonged correction which older funds have. While our rating criteria makes some provisions for funds with shorter track records, the lack of a low-returning period has helped some of the newer funds score well on ratings.

Mirae Asset Hybrid, part of Prime Funds, has therefore seen its ratings slip now to 3.5. The fund’s 1-year returns against the Nifty 50’s hybrid index had also slipped, which has had an impact on its rating. However, in recent times, the fund’s returns have moved back higher. It has delivered against the category average as well. It remains a lower-volatile performer with above-average risk adjusted returns. We are watching this fund’s performance and will make any changes if necessary. The other funds in this Prime Funds category continue to record strong performance.

Debt funds

Debt funds have seen portfolio yields finally move higher across the board over the past few months, reflecting the higher interest rate scenario. Longer-maturity funds remain low-returning as rising rates impact bond prices. However, we have been highlighting different pockets of attractive yields, from target maturity funds to g-secs to t-bills. We’ll continue to do so, which you can use to supplement your debt portfolio.

A lot of factors are set to influence where rates go from here. We recently discussed these in our report on where to park short-term money. If you have a short-term timeframe, you can use a mix of debt funds and other options as mentioned above. For longer-term portfolios, the best way to navigate the current rate scenario is to use a mix of short-term and medium/long-term funds.

Debt – very short term

In this category, we have added Kotak Low Duration. This was a fund that was always a good performer but came with very high credit risks. However, the fund has gradually pared its exposure to low-rated papers and holding in below AA+ papers is about 6%. The fund has still managed to keep its returns and portfolio yields above average. The fund deftly juggles allocations between CPs, CDs, treasury bills and short-term bonds. It also takes tactical calls on g-secs to make returns off bond price rallies. For this reason, the fund is more volatile than peers in very short term periods such as 1 week. The fund can be used by any investor to invest short-term money, or as part of an emergency portfolio, or to run SWPs.

Debt – Short term

In this review, we have removed IDFC Banking & PSU Debt. At this point, we’d prefer to go with short duration funds with a wider investment mandate, which have managed to increase portfolio yields. The IDFC fund’s portfolio yields have been below average for a few quarters now, though average returns are still better than the category.

For investments already made, continue to hold for the intended timeframe. For any SIPs, you can stop the SIP and restart the same in funds in the Debt - Very Short Term category or from the Debt – Short Term category depending on your timeframe.

Debt – Long term

In the long-term category, the options available have typically been limited. This earlier explanation on the different categories that fit a long-term timeframe will explain more. This quarter, we have added Edelweiss Banking & PSU Debt fund to introduce diversity in this category. This fund invests in debt issued by banks and PSUs, besides SDLs and g-secs. The fund has a long maturity of close to 7 years currently. 

The fund, however, follows a roll-down strategy which means that maturity will gradually reduce over the years. This works well for longer-term periods, as it can see returns shine when the rate cycle eventually turns lower down the line. Its current portfolio yields are well above both peer average and the corporate bond category. The fund has steadily delivered returns above its peers and short-maturity funds as well.

The fund suits any investor with a horizon of at least 5 years. You can hold this fund along with other short-term funds and corporate bond funds for a diversified debt portfolio.

Prime ETFs

Prime ETFs is our list of recommended ETFs in equity, debt, and gold. We look at multiple factors to draw up this list, ranging from short-term and long-term tracking error, expense ratio, trading volumes and usefulness of the index in a portfolio. In this review, we have made only a few changes.

Moderate risk

In this category, we have added SBI S&P BSE Sensex ETF and removed the HDFC S&P BSE Sensex ETF. The SBI fund has improved on its tracking error and is now better on this count than the HDFC ETF. Its trading volumes have also improved and are above that of HDFC. You can hold all investments made in the HDFC Sensex ETF; if you do not wish to increase the number of ETFs you hold and the marginally higher tracking error does not concern you, you can continue with the HDFC ETF for fresh investments as well. Else, make any fresh investments in the SBI ETF.

Themes & strategies

In this Prime ETF category, we have added Mirae Asset S&P 500 Top 50 ETF. This ETF tracks the S&P 500 Top 50 index, an international index that houses the top 50 stocks from the S&P 500 index by free-float market capitalisation. The S&P 500 itself comprises the 500 largest stocks in the US by market capitalisation.

This index is a good replacement for the S&P 500 index as it contains a good part of the S&P 500’s weight. In terms of performance, the two indices are closely correlated and share similar trends. The index is less volatile than the other US bellwether Nasdaq 100. It offers a different option to invest in the US markets; with the RBI restrictions on funds investing internationally, most of the available options track only the Nasdaq 100 index. In our view, for investing in US markets, passive is a better choice than active funds.

The Mirae S&P Top 50 ETF has seen reasonable volumes, though tracking error has been high during the months when the RBI restrictions were in place. The ETF can form part of 5+ year portfolios. Cap international exposure to 10-15% of your portfolio.

You can see the updated Prime Funds list here.

You can see the updated Prime ETFs list here.