Prime Funds performance in 2022

The close of another year means that it’s the time we review how our recommendations have done. We published our Prime Stocks report card a few days ago. In this instalment, we cover Prime Funds, our fund recommendations.

When we pick Prime Funds, what we look for are performance consistency, the ability to rein in losses, and the fund’s strategy. We tend to prefer funds which are solidly established and which have displayed the ability to stay ahead of markets. In each Prime Fund category, we also try to introduce variety in strategy. 

This year, while our debt and hybrid recommendations have been solid performers, our equity fund recommendations have fallen behind for the first time. There are different reasons for this underperformance, and which has implications on how you should manage the equity section of your portfolio. More on all this, below.

Prime Funds – Equity

Stock markets in 2022 have been anything but unidirectional. A tepid first half weighed down by myriad concerns shifted into a wild second half with the Nifty 50 and the Sensex scaling new highs. But in this, there are a few trends that took shape.

One, the smaller market-cap segments have not yet fully pulled back from their slide earlier this year. The Nifty Smallcap 150 is yet to reach its earlier high and the Nifty Midcap 150 is just about there, having also lost much more than the Nifty 50 or the Sensex did. Two, the sector churn in markets were quick and sharp and even within sectors, stock movements were swift. Earlier market favourites also gave way to other underperforming sectors. Timing played a more pivotal role in catching outperformers and holding onto gains.

As a result, some funds found it much harder to cope and stay ahead of indices. These include funds that were markedly buy-and-hold, or went by stable fundamentals, or were growth-and-quality oriented instead of value-based, or undertook less portfolio churn. Others that were more dynamic or just plain lucky in picking winners shone. This trend comes after two years where heady markets lifted several stocks to lofty valuations, where fundamental strength of a stock took a backseat – which again saw some funds turn outstanding performers and some turn laggards as they avoided risky picks. Consistency in performance, thus, is dented. 

We have been observing these different trends unfold and have therefore modified our approach to fund selection to be more dynamic:

• Become quicker in adding outperformers to avoid missing opportunities, especially in the Equity Aggressive bucket. We usually are cautious and wait for sustained outperformance before we add funds. However, with the shift in markets, we have picked up fresh outperformers that have been able to navigate these markets well, without waiting for the fund to build up a long outperformance – provided the outperformance was strong, fund portfolios sound, and strategy clear. 
• Become stricter with underperformers. We normally offer good legroom for otherwise consistent funds to recover. But with the market churn, some of these funds have seen severe underperformance and their strategy and portfolio, while sound, may make it harder for them to catch up. In these cases, we have been stricter and removed them from the list and asked you to stop SIPs without waiting unduly for improvement.
• Focused on sector/thematic funds to play the different pockets of opportunities. We adopted two approaches here – one, we added themes that were turning around such as auto and manufacturing in 2022, to stay in line with the market’s preference. Two, we retained (from previous year) those that were not in favour – such as IT or pharma, as bets that can pay off later. 
• Insisted that you add passive funds, especially in the indices that are marketcap-weighted. We have refrained from adding more factor-based passive funds, as we have observed several of these indices fail to match up to their market-cap weighted parent indices.

Equity – moderate

Our funds in this Prime Funds set are drawn from the large-cap, flexi-cap and value categories. Since we began Prime Funds, this is one bucket where we have had the least changes. 

That comes from our observation that the Nifty 50 or the Nifty 100 have become formidable indices to beat – and this has only strengthened this year. While many large-caps rebounded well during the 2020-21 periods, that performance failed to sustain in this year. More, even the hitherto consistent kings of Axis Bluechip, Canara Robeco Bluechip, Mirae Asset Largecap or Baroda BNP Paribas LargeCap lost that edge. As a result, most funds fared poorly. On an average, large-cap funds delivered 5.47% in 2022, against the 7.4% of the Nifty 100.

Some of the funds mentioned above are in Prime Funds. Our set also contains large-cap dominant funds from the flexicap category, which have exhibited the same trends. Overall, our performance has been as below.

The steep underperformance against the index comes primarily from two funds:

• The large-cap picks turning underperformers – Axis Bluechip is a big influencer here that has pulled down the average. The fund lagged the Nifty 100 by even double-digit margins at one point. We removed the fund in the recent September quarter review. The year-to-date return stands at -3% for the fund (as of 12^th December).
• Parag Parikh Flexicap seeing returns take a hit from its tech-heavy US exposure. While its domestic picks have done well, the steep US correction and the high exposure to US stocks hurt badly. We remain comfortable with the fund’s overall strategy and performance and see no concerns over its performance. The year-to-date return stands at -4.4% for the fund (as of 12^th December). Removing this fund and Axis Bluechip from the calculations brings the Prime Funds average returns up to 6.3%! 
• The above two apart, our other two large-cap funds have also lagged the Nifty 100. However, their underperformance is not too severe, their portfolios hold strong, and there has also been some improvement in performance of late.

With the removal of Axis Bluechip and our addition of ICICI Pru Value Discovery, this Prime Funds set also featured far more value-based funds. This is another aspect where we have deviated from our traditional approach of having a mix of styles – as skimping on value-based funds now would mean lost opportunities. The other value picks in this category – Kotak EQ Contra and Invesco India Contra have done well, too.

Equity - Aggressive

Funds in this Prime Funds set are drawn from all categories. Here, we were more aggressive in adding mid-cap and mid-cap oriented funds this year; we made a total of 6 fund additions in this set while we pulled 3 out. The performance of this category is below.

While in this Prime Funds set as well, the overall average performance is marginally below category and benchmark, we’re not unduly worried here. Here are the key highlights behind the performance.

1. Just 2 underperformers drag returns: Two big underperformers are DSP Midcap and UTI Flexicap; the average return jumps 2 percentage points to 6.64% if we do not consider these two. We already removed the former in the June 2022 review. The UTI fund has taken somewhat of a contrarian sector call in its portfolio, which has weighed it down, and we’ll watch performance here. Other underperformers against their benchmarks were Invesco India Midcap – which we removed from the list in the September quarter – and SBI Focused Equity which has begun to recover.
2. Funds slacken in rangebound market: Another factor is that many funds saw underperformance in the October-December period, when markets were rangebound outside of the Nifty 50. However, this is not a significant cause for concern as funds in this set otherwise do well to capture upsides; in the June-September period, for example, when markets began picking up, all funds in the list managed better than the Nifty 500.
3. Contain downsides well: Downside containment is a key metric we consider especially in these higher-risk funds. On this front, our picks did well. For example, midcap and smallcap funds such as Kotak Emerging Equity, SBI Smallcap, Union Smallcap and such held up in the corrections of the first half of 2022.

Equity – Strategy/ Thematic

We have been fairly active in this set to pick different opportunities. 

• Additions we made to ride the economic recovery worked well – auto and manufacturing. We had retained our recommendations in banking & financial services through the phase of poor returns, which has played out handsomely with the sector at the forefront now. 
• Other thematic funds we held on to in the list as prospects held strong – consumption and infrastructure also beat the Nifty 500. 
• We had issued a book profit call on our commodity fund recommendation as commodity prices cooled off globally, in order to lock into the gains made. In that call, we had also made a case to continue holding the remaining investment in the fund, and the fund has continued to deliver.
• We retained our contrarian calls in pharma and IT; both sectors are out of favour but we still think there is value to be had in these sectors.

Overall, ignoring the IT and pharma calls which are meant to remain contrarian this year, the thematic Prime Funds returned 12.6% on an average against the Nifty 500’s 6.8%.

Prime Funds – Debt

Debt funds have finally seen improvement in yields and returns in most categories, after years of low returns due to the low-interest cycle. Through the year, we have issued several strategies, outside of Prime Funds, to use the transition from low to high interest rate to your advantage. 

In Prime Funds, we had been active both in 2021 and 2022 to set up recommendations geared for a shift in rate scenario. We especially added to the very short term and short-term categories, where the effect of rate hikes would be the quickest. A key recommendation change we made from the fag-end of 2021 and into 2022 was to be more inclusive of funds taking credit calls. With the shadow of Covid lightening, corporate credit-worthiness improving, and credit demand recovering, the overall credit environment became more comfortable and worth taking the risk for the stronger yields. 

Our debt fund recommendations have continued to deliver returns superior to their peer averages. Our timely spotting of opportunities and quick changes, apart from picking strong performers, have helped deliver well.

Debt – Very short term

In this set, we made just two additions – one was a Bharat Bond passive fund to capitalise on the good yields and the other was Kotak Low Duration. The other funds in this set draw from the ultra-short, low duration and money market categories. Every single one of these Prime Funds has beaten the category average.

Remember that even small return differentials are significant in the debt category. Funds such as Aditya Birla SL Floating Rate and Nippon Low Duration were especially good performers returning about 4.7%.

Debt – Short Term

This set did not see much change, other than introducing a Bharat Bond fund, and another short-duration fund in the December 21 review (which came out on January 22). We removed an underperforming banking and PSU debt fund, as short duration funds saw better returns and better portfolio yields. Overall, here’s how this Prime Funds set performed.

Our focus on picking stable above-average performers, and which have portfolio yields that are in line or better than peers’, has helped us beat the category averages. This apart, given that we go by fund maturities and timeframe, rather than rely on SEBI’s categories, also means we’re able to pick the right opportunities.

For example, the two floating rate funds we have here have scored well. HDFC Floating Rate Debt, has been a strong performing using both the ‘floating’ aspect and measured credit calls to its advantage. We removed the banking & PSU funds as yields in other categories showed better pay-offs.

Debt – Medium Term & Long Term

We clubbed these two Prime Funds categories together as we have a few funds common between the two. We have not made much change in either of these categories; they already house strong performers and these funds continue to be better than their peers. We haven’t yet found funds that are better on a consistent basis! 

That is, without going in for credit calls as many medium duration funds do. But we have opted to recommend pure credit risk funds for those who want higher yields for the higher risk; in our view, mixing a credit risk fund along with a stable high-quality fund is a better proposition than going for halfway blends of high-quality funds that take some credit calls. Here is how our funds performed.

This year, we added HDFC Credit Risk to join ICICI Pru Credit Risk. These two funds delivered 4.1-5.5% We also added Edelweiss Banking & PSU Debt, a fund with a long maturity following a roll-down strategy. With long-maturity funds seeing returns taking a beating as rates climbed, this was a good opportunity to get into these funds at lows. 

In fact, if we remove the fund from the duration category that does not perform in rate hikes  - SBI Constant Maturity -  Prime Funds delivered a far better 4.28% against the corresponding category average of 3.2%.

Prime Funds – Hybrid

We haven’t made many changes to our hybrid fund recommendations this year. We continue to classify these funds between low and moderate risk depending on their equity exposure and volatility, and we continue to be conservative in our choices given that these funds are mostly used either for short-term timeframes or by investors with low risk appetites.

Hybrid Moderate Risk

In this category, we restored ICICI Pru Equity & Debt as it firmly recovered from a long period of low returns. Its value tilt worked in its favour. We also added Edelweiss Balanced Advantage here, as its aggressive nature and market conditions lined up to deliver better-than-average returns. While the aggressive hybrid funds in this list are not the chart-toppers, they are still stable and beat their peers. Overall, this Prime Funds set delivered as follows:

All our recommended funds, save Canara Robeco Hybrid Equity, have beaten the category average through the year; outstanding performers here were ICICI Pru Equity & Debt as well as ICICI Pru Balanced Advantage. The Canara fund alone fell a little more sharply in the early part of the year, but has since bounced back well.

Way forward

While we are confident we will continue to calibrate our debt strategy and deliver, in equity, it may become necessary for you to have the following in place to ensure inconsistency in equity funds does not hurt your portfolio:  

• Less active in moderate risk: For moderate-risk equity exposure, hold at least some exposure to the main Nifty 50, Nifty 100 or Sensex indices. This is even if you hold active funds – the rising performance inconsistencies make it difficult to rely on active funds alone. To beat markets and improve portfolio returns, you can instead use aggressive funds (whether from Prime Funds or your own analysis) or thematic funds.
• More market-cap based indices: These are indices such as the Nifty 50, 100, 500, Midcap 150 and so on. It is increasingly becoming evident that they are the best fit for core passive portfolio exposure; and not factor-based indices no matter how fancy they may seem. Treat factor-based indices only as diversifiers and not your main portfolio holding.
• Active funds require active tracking: Gear up for more hands-on management of the equity funds you hold, unless you hold only passive funds. Earlier, funds that were otherwise consistent usually bounced back from short-term underperformance and underperformance in such quality performers were manageable. Now, however, many funds trail benchmarks by a significant margin and with dynamic markets, it can get much harder for these funds to pull back even if they make an effort to change their portfolio. Therefore, you need to be a touch more vigilant and open to switch out of these funds in order to avoid opportunity loss. We will also continue to be a little stricter with underperformance in equity funds, unless the fund has shown that it is course-correcting and its portfolio remains sound.