Quarterly review – changes in Prime Funds, our mutual fund recommendations

Prime Funds is our list of recommended mutual funds across equity, debt, and hybrid categories. We use Prime Ratings, our fund ratings, as a first filter and then use qualitative analysis to narrow down to the list of Prime Funds. Prime Funds are an enduring list of funds that you can use, and you will find a fund that meets any goal you’re looking to meet.

Our aim in reviewing the Prime Funds list every quarter is to ensure that we don’t miss any good opportunities that are coming up and we are not holding on to funds that are slipping. When we remove funds in the Prime Funds review, we tell you exactly what to do if you have invested in these funds.

Changes in direct/regular calls

In our previous review cycle, we introduced a separate call for funds where the regular plan had a far higher expense ratio than the direct and this was significantly influencing the fund’s performance. From this cycle around, we’re becoming stricter.

We have noted several funds – in equity, hybrid, and debt – where the differential in the direct and regular expense ratios are much higher than average. But these funds are all not poor performers or low rated – several are category toppers. That is, a regular plan, even with a high expense ratio, has delivered well compared to its category.

However, with a research service like ours, there is little need for you, our subscriber, to stick to funds with a higher-than-average expense differential, even if the regular plan offers value-added services. The direct plan of the same fund makes for a far better option.

So far, we have held that you could use the regular plan version of the Prime Funds if you wished to. From now, this will not be the case. Where we see a very high regular plan expense ratio compared to the direct plan, we have issued a ‘Buy through direct’ call. This will be provided in our MF Review Tool. So check here if you wish to invest in the regular version. Funds where we don’t make specific mentions can be invested through direct or regular.

Now, on to the changes.

Equity funds

We make this review at a time when equity markets had a dizzying rally that now appears to be losing steam. This comes against the backdrop of an economy climbing out of the pandemic-induced slide and companies grappling with changed markets, cost structures and funding scenario.

With this rally sweeping mid-caps and small-caps and a much broader range of stocks, several funds with not a steady record otherwise, have better performance now. We tread with caution at such times. A wide rally such as the one in 2020 pulls in both quality and poor stocks. Though earnings numbers are recovering in the September and December quarters, sustaining this recovery is essential to support valuations. If the rally should take a breather, funds that rode this wave could slip back.

Therefore, we have been cautious in adding funds this time and given funds that are lagging the super performers in this rally, time to improve. Here are the changes we have made, in each equity category in Prime Funds.

Equity – moderate

We have added Kotak India EQ Contra. This value-based fund adopts a focused approach with higher concentration to stocks and sectors. It can significantly deviate from benchmark allocations, given its strategy. This fund is large-cap oriented and aims to remain so. This fund has been a steady outperformer, beating the Nifty 500 TRI across short-term and long-term periods. Most value funds sport lower consistencies as they spend a long time lagging the index. The consistency that Kotak Contra shows is a good sign of being able to sustain returns.

This fund is similar in strategy to Kotak Standard Multicap, though the portfolio overlap is not extremely high, holding at about 63%. Therefore, if you already hold Kotak Standard Multicap, give this fund a miss. Consider it if you’re building a fresh portfolio.

Separately, note that three funds in this Prime Fund category – Parag Parikh Long Term Equity, Canara Robeco Equity Diversified and Kotak Standard Multicap – have changed over into the newly-introduced flexicap funds. There may be a name change as well. We have already explained this here.

Equity aggressive

We have not made any additions here. However, we want to make a mention of a few funds here that are underperforming in this rally. The first is Invesco India Growth Opportunities. This fund has fallen behind the Nifty LargeMid 250 from around August 2020 onwards. This lies in the fund’s relatively lower mid-cap allocation, at a time when mid-caps were soaring. The fund’s top portfolio picks, with higher weights, such as HDFC Bank and ICICI Bank have not participated as much in the rally.

The second is SBI Focused Equity. Returns for this focused fund, like Invesco Growth, has been trailing the Nifty 500 TRI from around September last year. It has been weighed down by a few picks not doing well, such as HDFC Bank or P&G Hygiene. This is the flip side of a focused approach.

Both these funds have a strong record of consistent performance, and we’re allowing them time to pull back above the index or narrow the gap.

Passive/ index

We have added UTI Nifty Index here, a fund that tracks the Nifty 50 index. This fund’s expense ratio is much lower than peers and it scores very well on tracking error across timeframes. Use this fund to make up the large-cap exposure of your portfolio. Avoid combining this fund with a Nifty 100 index fund/ETF. The two indices move very similar to each other. Therefore, hold either one of the indices.

Strategy/ thematic

Here, we have added Tata Digital India to play the IT theme. We had Franklin India Technology to play this theme before. We have now replaced this with Tata Digital India.

We had already had a positive view on the IT sector. The Covid-19 pandemic has increased the urgency of digital transformation, positioning the IT sector to emerge as a strong growth story. Several imperatives – enabling access for work-from-anywhere, shifting to cloud (and related cyber security and infrastructure management requirements), digitization of operations, plugging gaps in workflows – have all provided significant opportunities for IT companies across the spectrum. There are now significant opportunities opening up in the domestic IT space. The recent December quarter results bear this out, with significant large deal wins and margin improvements as companies optimized cost structures.

Franklin India Technology was both a global and domestic play as it invested directly in global IT stocks and in Franklin’s global technology fund. With domestic opportunities now opening up, we’re preferring a more domestic play. This apart, global tech exposure can also be had through the Nasdaq 100 (also part of Prime Funds), which serves an additional portfolio role of access to other US giants. If you hold Franklin India Technology, remain invested but do not increase exposure.

Tata Digital India is a more consistent and better performer compared to other funds on the tech theme across short-term and long-term periods. This theme can be held for a few years, but ensure that you keep allocations limited. If you own large-cap IT stocks directly, skip this fund. You can add the Nasdaq 100 if you wish to.

Hybrid equity – moderate risk

We have, in multiple reviews, highlighted the inconsistencies in the hybrid aggressive fund category. Equity savings and balanced advantage funds meet the need for a debt-plus return, tax-efficient option for shorter-term holdings. For long-term portfolios, hybrid funds do not play a significant role in either introducing debt or giving you style diversification.

However, investors with smaller investment amounts can find it difficult to build properly asset-allocated portfolios. In such cases, hybrid aggressive funds work well. If you have a larger sum to invest and you can asset-allocate using pure equity and debt funds, ignore these funds and use only pure equity/ debt funds for your portfolio.

In this review, we have added Canara Robeco Equity Hybrid. The fund has for long been an average performer but has pulled above category average in the past few quarters. Its equity allocation is similar to Canara Robeco Bluechip, an above-average large-cap fund, and it is mostly large-cap based. On the debt side, it sticks to top-rated debt and can take some duration calls. It scores very well in containing losses, a key positive in hybrid funds.

We have removed SBI Equity Hybrid as the fund has been slipping in performance over the past two quarters. If you have SIPs in this fund, stop the SIP. Where possible, use pure equity and pure debt funds to replace the SIP, based on your portfolio allocations. For investments made so far, continue to hold and exit at a later date only if your need to consolidate your portfolio.

We had moved ICICI Pru Balanced Advantage into this category from the Hybrid – Low Risk category in the previous review. Its higher unhedged equity compared to peers weighed on returns when markets were correcting; its downside capture is therefore worse than category. This is among the reasons the fund’s Prime Rating has taken a blow in this review. It has significantly upped its hedging position now, to the tune of 26% of its portfolio in December from the less-than-10% it was before. This can help it better than before, if markets correct, though it certainly has prevented the fund from capturing the recent market rally. Its 1-year returns remain on par with the category average.

Debt funds

As we mentioned in our  debt outlook, further rate cuts seem remote with both the economic recovery taking shape and inflation rising. But with the need to keep the economic stimulus going, rate hikes may not materialize at least in the next few months. The RBI has moved to shut off the extraordinary moves it took during the pandemic; short-term yields have already spiked in consequence.

In debt markets too, the scenario is dicey to call at this time. Nor do we want to up credit risk as we’d prefer to see how credit quality plays out as normality fully resumes in bank & NBFC NPA declarations and provisioning. Therefore, we are cautious on debt as well.

Here are the changes we have made.

Debt – liquid

We recommend liquid funds for those looking for such funds to hold money for a very short period, or as part of emergency portfolio, or to generate steady income through SWPs. If you have STP requirements, choose a liquid fund in the same fund house in which you have chosen the equity fund, whether it is in our list or not.

In this review, we have added ICICI Prudential Liquid fund. This fund has a very large AUM, and has delivered above-average returns. The fund has also moved up in our ratings over the quarters.

We have removed Franklin India Liquid . This fund, in terms of performance, held above other liquid funds. However, its AUM, which had stabilised earlier, has since dropped below Rs 2,000 crore. Owing to the smaller size, and availability of other large liquid funds with steady performance, we have removed the fund from our list.

If you are running STPs from this fund into other funds from the AMC, let it continue. Similarly, if you have invested in this fund with a near-term horizon, you can remain invested. However, if you are using the fund for SWP, or as part of your emergency portfolio, it is best to shift entirely out of Franklin India Liquid and move into another liquid fund from the Prime Funds list.

Debt – Short Term 1.5 to 3 years

In this Prime Funds set, we added Kotak Bond – Short Term. This fund takes no credit risk and does not have concentrated exposure to individual issuers. Its average 1-year returns rolled over 3 years hold well above the average of short duration and banking & PSU debt funds – which is not easy, given that this would include funds that take credit risk plus those that get a return boost through duration. While its portfolio maturity is between 2-4 years, it can be slightly longer than peers. However, this has not translated into higher volatility and the fund sports fewer instances of negative short-term returns compared to category.

HDFC Short Term Debt, part of this set, now has marginal risk in papers rated below AA+. For those looking for an entirely top-rated portfolio, Kotak Bond Short Term is a lower-risk-marginally lower return alternative to HDFC Short Term. Use this fund for goals at least 2 years away and combine it with banking & PSU debt funds. Avoid using this fund for goals less than 2 years away.

Debt – Long Term – Above 5 years

Here, we have removed Franklin India Corporate Debt. We had this fund to provide higher returns for long-term portfolios, as it sported higher yields and was a consistent above-average performer. However, it has upped its cash component to 15% of the portfolio now. This can impact returns going forward. For fresh investments, this can mean an initial period of low returns until the fund deploys the cash.

If you have invested in the fund, remain invested. For earlier investors, the fund’s strong and consistent performance until now means that returns have been built and can withstand a period of lower performance. Its average 1-year return rolled over 3 years, at 8.8% is well above the 7.4% corporate bond and medium duration funds averaged. If you have SIPs, you can stop these until the fund improves. Please note that this fund is meant to be held for at least 5 years. Also note that this is not an AUM call we’re taking – the fund has, in fact, seen its AUM rising steadily over the past 4 months.

We have not added any fund in its place. One, we do not see any longer-term fund with a consistent strategy. Two, we do not want to add duration – which is otherwise a fit in this category – or credit risk until there’s more clarity on rate direction and corporate credit quality.

You can view the full list of Prime Funds here.