Parag Parikh Flexi Cap – should you continue to invest?

Up until six months ago, Parag Parikh Flexi cap was an investor favourite. Its chart-topping performance and overseas investments served as the key attractions. These very same factors now appear to be doing the opposite, causing investors to worry over continuing investments.

So, should you be concerned over Parag Parikh Flexi Cap’s performance? Is the restriction in investing abroad a game-changer for the fund? 

In our view – no. There is no cause for concern over the fund’s performance or portfolio and investments can continue to be made. Three reasons why:

• Part of the reason the fund was propelled into the limelight was its overseas exposure. This certainly set the fund apart from other diversified equity funds but it was not the only factor that was driving performance. The fund has other USPs, too, that make it an outlier in the flexi-cap category.
• The fund’s strategy is to make long-term calls based on business and valuations, and top holdings are often concentrated. Some of these stocks have corrected in the past few months, thus weighing on performance. These are stocks that are otherwise strong in potential and have delivered smartly earlier. 
• The fund is a low-volatile performer but does go through bouts of underperformance over 1-year periods. It keeps a low portfolio churn, following a buy-and-hold strategy and therefore necessarily requires more patience and a long-term holding. It has shown the ability to exit underperformers, book profits in those that rallied, pick up others at opportune times. 

Here’s explaining further.

Recent performance

Let’s start with how Parag Parikh Flexi Cap has been performing in recent times. On a point-to-point basis, the fund’s 1-year return of 7.1% is below the Nifty 500 TRI’s 9.8%. On a 3-year and 5-year returns, however, the fund beats the index by 6 percentage points.

Considering very short-term returns of 1 month or 3 months, the fund has been lagging the Nifty 500 TRI from about March onwards, the effect of which is now being seen in the 1-year return. However, two factors offer some comfort.

One, the extent of the underperformance in the 3-month returns is not deep, holding at about 1-3 percentage points on an average. Parag Parikh Flexi is also not much worse off compared to peers from the flexi cap, value/contra & dividend yield categories, returning above, or on par with, category average across these timeframes. Marginal underperformance is not too worrisome, especially with the rollercoaster ride that stock markets have seen since the start of this year. With a sound strategy and portfolio in place, this kind of  underperformance is easier to bounce back from. 

Two, this underperformance gap already shows indications of narrowing, against the Nifty 500 and the category average in the past couple of weeks. This improvement is already making an impact on the 1-year returns; Parag Parikh Flexi Cap now trails the Nifty 500 TRI by 2 percentage points, down from the 4-5 percentage points it was earlier.

Other key parameters, which make it an outstanding fund, remain strong. Over a 3-year rolling return, the fund beats the Nifty 500 TRI all the time in the past 6-year period. It manages better downside containment than the index and peers; based on 1-month returns, Parag Parikh Flexi Cap captures just 59% of the Nifty 500’s declines. The average for its peers is far higher at 94%. That means it fell a lot less than the index. It continues to remain low-volatile, even in these markets.

Portfolio choices

The underperformance in Parag Parikh Flexi Cap can be explained by its portfolio and strategy. The fund has always adopted a buy-and-hold long-term strategy, picking stocks with sound fundamentals and attractive valuations. It keeps a low portfolio churn at an average of 20%, including derivative transactions. It holds a heavily concentrated portfolio – the top 10 stocks often account for 60-65% of the overall weight.

International exposure

Consider its much-vaunted overseas exposure. The fund, unlike popular belief, does not hold only Nasdaq stocks; it picks stocks from across different markets and different segments. It has earlier held stocks such as 3M and Nestle, for example, and currently holds Suzuki Corp. But its tech stock holdings such as Alphabet, Amazon, and Microsoft have certainly hurt recent returns, and the fall in these stocks has been sharp as well. Their heavy portfolio weight added to their impact on overall returns.

Other funds investing overseas, such as Axis Growth Opportunities or Kotak Pioneer which has a heavy Nasdaq index weight, haven’t suffered as much as Parag Parikh Flexi Cap in returns. But this can be partly explained by the fact that the Parag Parikh fund hedges close to its entire currency exposure which the other funds do not undertake. The rupee depreciation absorbed some of the losses from the overseas stocks for these funds, leaving them with smaller impacts.

The restrictions on overseas stock investments also meant that Parag Parikh Flexi Cap couldn’t take advantage of the price dips. However, there is some relief on this front – the global market decline allowed some headroom in the overseas investment limit and SEBI allowed funds to invest again up to this limit in June. Parag Parikh has used this opportunity to up stakes in stocks such as Alphabet and Amazon.com. As of June 22, overseas securities account for 22% of the portfolio. In January, just before the restrictions, the fund held 29% in these stocks. 

The fund, therefore, continues to benefit from overseas diversification. The fund has always held only a few quality stocks with heavy weights. Its use of the investment window opening up also appears prudent. Equity, whether domestic or overseas, will always be volatile in the short term.

Domestic portfolio

Parag Parikh Flexi Cap’s domestic portfolio is primarily large-cap oriented. In the past few months, stock choices such as CDSL, Power Grid, Hero Moto Corp, Coal India, Balkrishna Industries, and Bajaj Holdings have either been flat or have declined in the year to date. Its many pharmaceutical stocks, too, have weighed on returns. 

Most of these, however, do hold strong potential. Stocks such as Bajaj Holdings and CDSL have been outstanding performers, delivering well for the fund. Other picks that hold it in good stead include ICICI Bank and IEX, which have returned smartly. It was an early entrant into ITC, where it booked profits given the run up in the stock and the high portfolio weight. Other stocks that aided performance include Persistent Systems and Mphasis.

The fund has also made interesting portfolio choices, such as exchanging an overvalued HDFC Bank for HDFC citing their eventual merger. It has also used derivatives to play arbitrage opportunities and earn additional returns off portfolio stocks. While it hasn’t stepped up overall hedging of its equity portfolio to the extent it has in years such as 2019, the fund still holds close to 10% of its portfolio in cash. This can help shield returns from market volatility and give the fund the firepower to invest on any further dips.

Bottomline

So, what are we trying to say here? 

• Parag Parikh Flexi Cap’s performance has not come just from its overseas exposure and overseas exposure is just a part of its overall portfolio. It cannot even be remotely viewed as an overseas fund, as seen by some investors.
• Its domestic portfolio choices have also been strong performance drivers. Therefore, the restrictions on investing overseas does not diminish the fund’s potential. 
• The other factors such as low volatility and downside containment continue to set it apart from other diversified equity funds.
• Its buy-and-hold strategy means that it will see bouts of poor performance. Its 1-year returns have dropped below the Nifty 500 in periods such as 2017 and 2014 as well. Therefore, it necessitates a long-term holding of at least 5-7 years and a willingness to bear short-term blips. 

The fund continues to remain as part of our recommended list – Prime Funds and in Prime Portfolios. You can continue your SIPs/hold the fund.

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