Quarterly review – Changes to recommendations in Prime Funds and Prime ETFs

Prime Funds is our list of recommendations in equity, debt, and hybrid mutual funds that are worth investing in. Prime Funds narrows down your choices from the thousands of funds that there are, into a concise list of funds that span different styles. Prime Funds are selected based on performance, portfolios, and investment strategies. 

In this quarter’s review, we have made limited additions to our list of Prime Funds but have some updates to give on performance of the existing funds. We also suggest buckets that are worth entering now. So do read it! 

Equity Funds

After a rally in the December 2022 quarter, the Indian equity markets once again buckled to the bear’s pressure in the first quarter of calendar 2023. Fear of a global banking crisis following the collapse of Silicon Valley Bank in the US and the buyout of Credit Suisse by UBS, besides geopolitical issues, continued to pull down markets globally. The Nifty 50 TRI index fell nearly 4% in the March quarter while the Sensex did a tad better with a dip of 2.8%. 

We did not find it surprising that our Prime Funds managed to contain downside reasonably well thus causing less damage.  We did make quite a few changes to Prime Funds in 2022, triggering views from some of you that we churn funds too often. We would like to clarify a few things on this to alleviate your concern before moving to the actual review:

• One, we rarely move a Prime Fund to a sell. If we decide to remove a fund from Prime Funds, we give a hold, after providing sufficient time for the fund to show improvement. A hold means you can retain existing investments and there is no reason to exit the fund. The reason we do this is to accommodate newer and upcoming performers so that those who invest afresh do not lose out on those opportunities. 
• Two, we do not stop tracking the funds we have moved out as we continue to provide our buy/hold/sell call on those funds in our MF Review tool. You can check the tool whenever you do your own portfolio review. These funds may later move to a buy, if they eventually do improve or to a sell if the situation further worsens. 
• Three, as we have mentioned on many occasions, if there are too many holds in your portfolio, you should consider consolidating them at some point – based on fund duplication (use our MF overlap tool as a starting point), or if you have too many funds in the same category with very low allocation. Do note that we cannot give sell calls on funds unless their performance is poor. So, there may be a good number of your funds bearing hold calls when you check MF Review tool if you have been investing for long. 
• Four, in the past 5-7 years, funds across categories have seen slippages in performance with very few managing to showcase consistency or managing a bounce back. Even where they do, there is an opportunity loss in the meanwhile. Active fund holding will call for some amount of active management of a portfolio on your part. We firmly believe in our philosophy of buy and hold equity for the long term. But we have never subscribed to the view that one has to be wedded to a fund for life 😊 While we are there to track fund performance, if you wish for a passive management of portfolio, then passive funds are a good way to do that. We have sufficient recommendations on the passive equity space to do so, and we have a readymade passive portfolio as well.

In other words, we do not churn funds, really, and gain nothing from doing so! With that said, let’s now move on to the fund additions and some performance updates on equity funds.

Equity – Moderate (Active)

There are no additions in this category. But we are glad to note that there has been improvement in the performance of a few popular Prime Funds that were starting to lag a bit. 

Mirae Asset Largecap, a widely popular fund, slackened in performance since July 2022. This fund was not alone as most largecap funds underperformed as a result of a selective rally in index stocks in the large-cap space. On a rolling 1-year return basis since February 2023, Mirae has started outperforming the index yet again. While its top sectors such as banking and technology did take a hit, quality stocks that were undervalued (such as HDFC Bank) held ground, allowing the fund to contain declines better. Holdings in energy and consumer stocks also contained falls. The fund fell 4.4% in the last 3 months as opposed to the Nifty 100 TRI’s fall of 6.2%. 

Canara Robeco Flexicap – a more growth-focused fund – also underperformed since July 2022 but is now narrowing the margin of underperformance to just a few basis points on a rolling 1-year return basis. The fund managed to contain the fall in the last quarter to 3.9% as opposed to the S&P BSE 500 TRI’s fall of 6%. As value investing took over, growth funds like Canara Flexicap did go through a rough patch. However, the present correction has ensured that funds with quality stocks withstood the market fall better. This fund too, with top holding in HDFC Bank, managed to shore up against the decline. 

We will continue to watch these funds for their performance, but as of now they have held up and are not causes for concern.

Equity – Aggressive (Active)

In this category, we have decided to add HDFC Small Cap, a fund that was in Prime Funds in 2020, which we later removed for underperformance. Unlike other HDFC funds that bounced back over the past year, this fund continued to underperform its category on a rolling 1-year basis even up to October 2022. 

However, post a short rally in the December 2022 quarter as well as the correction in the March 2023 quarter, the fund’s portfolio staged a turnaround, delivering 6.7% in the last 6 months, as opposed to -0.7% category average. While the fund struggled with burgeoning asset size earlier (a primary reason behind us removing it from our list), with the definition of small cap growing over the years to about Rs 17,000 crore and above now (SEBI defined), the fund has managed to deploy efficiently in small caps. Its present 80% allocation to small caps is higher than category average of 69%. We believe the higher small cap exposure of the HDFC fund will give it an edge in terms of performance, given the current weak market. 

Investors looking for fresh small cap exposure can consider some lumpsum now and then follow it with SIPs. Please note that we have added the fund on early signs of turnaround. To this extent, the fund is a risky bet and its Prime Rating is low. Keep exposure limited.

Another fund in our Prime Funds list that saw some slippage in performance since July 2022 was Mahindra Manulife Midcap. While this fund is still trailing the benchmark on a rolling 1-year return basis, returns in the past 3 months are significantly better – with decline of 1.68% as opposed to category average fall of 4% and index fall of 4.8%. As we do not have any concern over its portfolio at present, we will continue to watch this fund for further improvement.

Equity – Aggressive (Passive)

There are no changes in this category. However, we would like to highlight the sharp bounce back in the passive US-based funds based on Nasdaq 100 and S&P 500 indices. The Motilal funds based on these indices have jumped over 15% in the past 6 months, as opposed to Nifty 50’s 3.2% return. While the inflow cap has meant that very few funds are today available for you to invest in these US market indices, do make sure you stay invested to provide diversification to your portfolio. 

Debt funds

After the change in the taxation rules for debt funds, many of you have asked us how we plan to change our recommendations from here. We explained the impact of the new taxation, what do with your existing and fresh investments last week. To summarize in brief:

• The role and utility of debt funds in your portfolio does not change, especially for short-term timeframes. 
• While the new tax laws open up potential in other debt instruments such as NCDs, gilts, or FDs, for long-term holdings, the need for debt funds still remains. 
• Therefore, we will continue as we always have with our debt fund recommendations and strategies based on rate cycles. Our approach to debt funds will not undergo any change, either.

Debt fund portfolio yields have seen a steady climb higher, across categories. The rising interest rate cycle tapering off means that there are opportunities to invest in both short duration and longer duration funds. We have made strategic additions to our recommendations in Prime Funds to cater to the different opportunities that opened up in the debt space. In this quarter, we have made one more strategic addition in the long-term category.

Debt – Long Term

In this Prime Funds category, we have added ICICI Prudential Gilt Fund. This is a normal gilt fund, and is the second gilt fund in this set after SBI Constant Maturity. Generally, we tend to avoid recommending pure gilt funds. Since we do not have certainty over the duration strategy a fund can adopt, it becomes tricky to know how volatile a fund may be or how returns pan out. Wrong duration calls can hurt returns.

However, we have taken a tactical call to add ICICI Pru Gilt due to its ability to take tactical calls in its portfolio, and because the current phase of the interest rate cycle is a good time to be adding to gilt exposure. ICICI Pru Gilt has, for example, loaded up significantly on floating rate bonds which both limit downsides and volatility and offer good yields at this time. The fund has clocked higher 1-year returns than other gilt or constant maturity funds. We may issue book profit calls or exit calls on this fund should the rate cycle shift into a downward cycle later on. 

Debt – Medium Term

In this Prime Funds set, we have made no changes. However, since returns here have been low and varying quite a bit between themselves, we wanted to highlight a few points. One, portfolio yields here have moved up significantly. ABSL Corporate Bond and Kotak Corporate Bond, for example, have a February portfolio YTM of 8%. ICICI Pru Corporate Bond sports a YTM of 7.98%. Therefore, as accrual kicks in, returns going forward are set to improve.

Two, as corporate bond funds are not bound by any duration mandate, maturity profiles vary across our recommended funds. HDFC Corporate Bond has the longest maturity – and the fund tends to maintain a longer maturity – of 5.23 years. This fund, therefore, has seen returns remain lower and seen a slower YTM pick up than the other funds in its Prime Funds set which have shorter maturity profiles. This is not worrying and is simply the nature of the fund’s strategy. 

Post the taxation change and at this juncture, the yields of these funds and the possible capital appreciation when a rate cut happens give an edge to corporate bond funds over target maturity funds. 

Debt – Very Short Term

In this Prime Funds set, we have made no changes. This set had the Bharat Bond April 2023 FoF. Since this fund has now reached its maturity date, we have removed the fund from the recommended list. The fund is set to merge into the Bharat Bond April 2025 FoF (which is part of Prime Funds Short Term set). If you do not require the proceeds of this fund to meet any expense, you can accept the merger and hold the Bharat Bond 2025 instead.

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 one addition. We had also made a mid-cycle change, which we simply highlight here.

ETFs – Strategy & Thematic

In this Prime ETFs set, we added ICICI Prudential Nifty Auto ETF. This ETF tracks the Nifty Auto index, which represents a mix of automobile manufacturers and component players. The index has a maximum of 15 stocks, and stocks are selected from the Nifty 500 and are weighted based on their free-float market cap. 

The auto space shows good promise, turning around post Covid. Pick up in economic activity has pushed up demand for commercial and heavy vehicles, while consumer demand has propped up especially higher-end passenger vehicles. This apart, the sector is also seeing a structural shift and transformation, especially in the EV space. All these hold this sector in good stead for the medium term.

The ICICI Pru Nifty Auto ETF is a new one; it only just completed 1 year in January. The ETF’s tracking error is not high, but the ETF does not see very high trading volumes; the daily average traded value is less than Rs 1 crore on an average in the past 3 months. Therefore, avoid deploying large sums in this ETF in one go.

ETFs – High Risk

In this Prime ETFs set, we removed the Nippon India ETF Next 50 Junior BeES last month – this was a mid-cycle change that we made. The detailed reasoning on removing the Nifty Next 50 from our recommendations is here, along with what to do with your existing investments.

The full list of Prime Funds can be found here.

The full list of Prime ETFs can be found here.