Quarterly review – Changes to Prime Funds & 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 review, we have added a new set in equity Prime Funds, and have made a few other changes in recommendations. Please go through the report in detail.

Equity funds

Equity markets have continued their late-2023 surge into the first quarter of 2024 as well. Sentiment over the mid-and-smallcap space soured following SEBI Chairperson Madhabi Puri’s comments over froth in mid-March; the Nifty Midcap 150 clocked a 5.5% fall at the worst period while the Nifty Smallcap 250 index tanked 8.5%.

This negative sentiment, though, proved to be fleeting. The ‘stress tests’ of the mid-and-smallcap mutual funds helped rekindle positive spirits as most funds showed the ability to handle market corrections in their stress tests. Rallying global markets, too, served to keep up markets. Net FII flows turned positive in March after a dip in February and DII flows, including mutual funds, remained buoyant. As a result, the Midcap and Smallcap indices clawed back to rally above the large-cap Nifty 50 by the first quarter of this calendar; the two indices are up about 6% in the year so far while the Nifty 50 is up by 5%.

That said, there are three important points to note. 

• One, given the sharp rally in these market cap segments, avoid going overboard on funds from this space. Stick to your original planned allocation to these funds and trim excesses here. 
• Two, while the overall indices have rallied smartly, several individual stocks have taken a hard knock. Funds holding a higher share in such stocks therefore have seen returns hurt. This apart, the overall phenomenon that we have explained in our earlier reviews of mid and smallcap funds lagging their benchmarks, owing to the nature of stocks they hold compared to the index, remains. 
• Three, as mentioned in earlier reviews, there remains a wide divergence in the performance of funds especially in categories which have a heavier share of mid and smallcap stocks.

We remain cautious on making drastic changes to existing Prime Funds based on their relative performance. Where the underlying portfolio quality is sound, there are signs of a pick-up in performance, and where peer funds have rallied primarily owing to market cap orientation, we will still retain these. If you hold these funds in your portfolio, therefore, you need to be prepared for some period of continued subdued returns.

It is also becoming increasingly important to pick up-and-coming funds, to capture the period where they swing high since outperformance in these instances are very high. This will help complement the more stable funds which, while consistent, do not offer outsized alpha over the long term. These are more tactical plays. We are adding a specific category within Prime Funds only for such opportunities.

Now, on to the changes for this quarter.

Equity – Moderate: Active

In this Prime Funds set, we are removing Mirae Asset Large Cap. We have highlighted the fund’s performance in earlier reviews. While the fund has shown brief periods where it beats the Nifty 100 TRI, the fund has more often lagged the index. Its short-term underperformance has continued enough to impact its longer-term returns as well. The fund is now about 1-2 percentage points behind the Nifty 100 TRI in 3-year periods, and this margin has been slowly swelling over the past few months. Therefore, in order to avoid further opportunity loss, we are removing the fund. Given its previous rock-solid performance, the fund could well recover. Therefore, hold all existing investments made so far in this fund. Stop SIPs, if any. You can start fresh SIPs in any other Prime Fund from this bucket or in a Nifty 50 index fund (our recommendation is UTI Nifty 50 index fund)

We are adding Nippon India Large Cap in this Prime Funds set, to replace the Mirae fund. Nippon India Large Cap has used the broad-based market rally to pick up well and beat the Nifty 100 TRI. Its 1-year returns were steadily improving from 2022 onwards and this has sustained and long-term 3-year returns too are steadily above the Nifty 100 TRI. The fund follows a strategy of adjusting sector weights relative to the benchmark to deliver alpha. It tends to have a value-based approach. The fund suits any investor with a minimum 5-year timeframe and pairs well with growth-oriented funds. 

However, given that large-cap funds in general have seen severe underperformance, it is very important to hold a Nifty 50 or a Nifty 100 index fund in addition to any active large-cap fund.

Equity – Aggressive: Active

In this Prime Funds set, we have made no changes. However, we would like to explain the performance of Kotak Emerging Equity. This midcap fund has earlier been a quality, consistent outperformer beating peers and the Nifty Midcap 150 TRI. However, the fund has been lagging both category and benchmark for a while now, and the underperformance is not small.

This is partly to do with the nature of stocks driving the Nifty Midcap 150, as we have discussed in earlier reviews, where stocks with poorer fundamentals have seen sharp climbs. Kotak Emerging Equity holds a portfolio of sound stocks; while these have delivered well, a handful of top index performers have not found place in the portfolio. Given the portfolio quality, we are giving the fund some leeway for its current performance. 

This apart, the fund has been adept at containing downsides, a key metric in these funds and especially in these times. In the March fall, for example, the average 1-week fall the Nifty Midcap 150 TRI suffered was 5.5%. The worst return for the Kotak fund was 3.9%. On an average, the Koak fund has been able to contain downsides well. The fund has also shown signs of overall improvement; going by 1-month and 3-month rolling returns, the gap between Kotak Emerging Equity and the Nifty Midcap 150 has been narrowing, with current returns of these periods above the index.

Equity – High-risk turnarounds

Under the Equity – Aggressive set earlier, we had a separate section called ‘Tactical’. We are now creating a separate classification under Prime Funds to house such funds called Equity – High-risk turnarounds, as we intend to be more proactive in making such calls, as outlined above. 

The aim here is to pick up funds as they show signs of an improvement in performance without a longer wait to judge the sustenance of this performance, as we typically do. The reason is because this transition period from underperformer to outperformer can be one of high returns. Capturing this can help improve overall returns. At a time when the average margin by which consistent and stable funds outperform is lower than in earlier times, making such tactical shorter-term calls can complement your portfolio well and help improve overall returns. 

We can give quick exits for funds in this Prime Funds set, if we see performance dipping. Please note that there is a higher risk in these funds as they are not yet fully established and improvement could quickly evaporate.

How to use these funds: These funds are to be used only in smaller allocations and never as part of your primary portfolio. These are also better used only for those willing to be more hands-on with their portfolio and not for those with a buy-and-forget approach.

In this set, we already have Quant Active. To this, we are adding two funds. One is Bandhan Core Equity, a large-and-midcap fund. This fund takes an approach of holding high-growth stocks along with value plays from cyclical themes or stock-specific. This fund saw performance picking up over the Nifty LargeMidcap 250 from late 2022, which has slowly built up over the past few quarters. Seasoned fund manager Manish Gunwani took over the helm in early 2023, and this offers comfort on potential continued performance.

The second is JM Value. This fund too has seen an improvement post fund manager change. Satish Ramanathan came in as the CIO for the AMC, and changes effected in portfolio construction began to bear fruit from 2022, with the past few quarters seeing very strong performance. The fund looks for mis-priced opportunities to gain from re-rating. It adopts a top-down approach to identify sectors with growth potential and then follows a bottom-up approach to pick stocks within the sector. 

Debt Funds

After a marginal dip, long duration yields are once again back to where they were a year ago, with the 10-year gilt at 7.15% now. Still, returns across categories have significantly moved up over a year ago. For example, the 10-year ICRA Composite Gilt index’ 1-year rolling returns moved from 4.3% a year ago to 8.5% now. The Nifty Short Duration index has moved from 4.7% (rolling 1 year as of April 8, 2023) to 7.5% now. 

While the 10-year gilt may appear to remain stagnant, pressure in the form of inflation has now subdued leaving less room for fear of rate hike. While our debt outlook remains the same, we have also to find options with better yields in the low end of the yield curve. 

With this background, here are the changes made to Prime Funds in this review:

Debt – Very short term: 3 months to 1.5 years

In this Prime Funds set, we have added Kotak Money Market simply to take advantage of the marginally higher yields in the fund. The fund has been a steady performer and does not exhibit any credit risk. 

We are instead removing Nippon India Low Duration. Please note that this fund is still a ‘buy’ in our review calls. We are simply keeping the Prime Funds list compact and keeping those with better yields for the same risk. If you are holding this fund, you can continue to hold it. The yield difference is too small to cause any significant opportunity loss if you hold this fund. There is no need to replace this fund.

Debt – Long term: Above 5 years

In this Prime Funds set we are adding one more gilt fund – SBI Magnum Gilt - to play duration tactically. This fund has significantly upped its maturity to benefit from a possible fall in yield. Its average maturity and therefore risk (at this juncture) is higher than the other gilt fund we have – ICICI Pru Gilt. Please note that the other SBI gilt fund in Prime Funds - SBI Magnum Constant Maturity has to stick to its mandated 10-year duration. SBI Magnum Gilt, though, can reduce or increase its duration based on its call on yields. For example, from an average maturity of 5.2 years in September 2023, it is now at 16.98 years. When a fund takes such dynamic calls, the upside is high when the call is right. And the downside can be steep if the call goes wrong. Hence, this fund can be viewed more as a tactical fund to play duration. It will need profit booking if a yield fall triggers high returns.

We have removed HDFC Credit Risk. There is nothing wrong with this fund and it continues to remain a Buy. We are simply not happy with the kind of yields that credit risk funds sport when compared to the corporate bond space. At an average YTM of 8.38% this category has now refused to take the risks it can, in order to get better accrual. Hence, we see less merit in having 2 funds from this space. We have retained ICICI Pru Credit Risk (owing to its marginally higher yield) and removed HDFC Credit Risk. It remains a Buy in our review tool simply because it is among the better performers in the category. You can continue to hold the fund but need not take fresh exposure considering less attractive yields.

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 a few additions.

Equity - Strategy & Thematic

In this Prime ETF set, we have added ICICI Prudential Nifty 50 Value 20 ETF.  This ETF tracks the Nifty 50 Value 20 index, which is a factor index that picks stocks from the Nifty 50 based on value parameters. These parameters are: return on capital employed and dividend yield (higher the better), price-to-earnings and price-to-book (lower the better). Stocks are scored on these metrics and the top scores make it to the index.

The index’s current sector and construct augur well for performance. The metrics help pick cash-rich, high-quality companies that could also help contain volatility. The Nifty 50 Value 20 index beats the Nifty 50 index steadily over rolling 1-year and 3-year periods, as well as large-cap funds. The index itself also has a good history of nearly 10 years of real-time index levels. The index fund is suitable for any investor’s long-term portfolio as part of the moderate risk component. It can be held even if you hold Nifty/Sensex ETFs.

While this ETF has a low tracking error, its traded turnover, at around Rs 84 lakh in the past 3 months, is not high. That means you should avoid high deployment in one shot and spread your investments. 

We have also added ICICI Prudential Nifty Commodities ETF. While Commodities as a theme is highly cyclical, the underlying index has a diversified basket of basic industries. The index is built as a diversified portfolio of companies from various basic industries representing the commodities space, including sectors like oil, cement, power, chemical, sugar, metals, mining etc. The stock universe is picked from a list of sector and thematic Nifty indices that fit the commodity label. The index comprises a maximum of 30 stocks with the weight of individual stocks capped at 10%. 

While the index has comfortably beaten the broad marketcap Nifty 500 over 3-year rolling returns, it has just about kept pace over 5-year rolling periods. This suggests that despite its broad-based universe of sectors, the ETF does need an element of timing to outperform the market. This is a high-risk ETF and only meant for those who know how to time their entry and exit in commodities. It can otherwise be avoided.

Debt and gold

We have added Bharat Bond ETF – April 2025 with a buy and hold till maturity strategy for those with a 1-year time frame now. With a yield of 7.58% at present, this short-term opportunity provides superior returns to many bank deposits and is ideal for those needing money in the next one year, who are keen on using debt ETFs. The fund has a portfolio of high-quality AAA PSU bonds with underlying instrument maturity in 2025. The fund is suitable for all types of investors provided your time frame matches the residual maturity. 

You can find the full Prime Funds list here.

You can find the full Prime ETFs list here.

Check our past quarterly reviews here:

Changes to Prime Funds and ETFs for the quarter ending December 2023

Changes to Prime Funds and ETFs for the quarter ending September 2023

Changes to Prime Funds and ETFs for the quarter ending June 2023

Disclosures & Disclaimers