Prime Recommendation: A thematic fund that actually diversifies your portfolio

Thematic funds need timing, in entry and exit. They’re there to kick portfolio returns up a few notches. They’re useful in capitalising on pockets of opportunities. Now, what if there was a thematic fund that turned this on its head? This theme does better than markets in correcting periods, delivers well over the long term, and can be a steady part of your portfolio without the need to time.

The theme here is MNCs. The fund we’re recommending here is UTI MNC, which is part of our Prime Funds list. For those looking to add a diversifier to their portfolio, this fund is a good fit. Please note that where we are referring to indices in the rationale below, we have considered the TRI.

Why MNC thematic funds

MNC contains downsides well

The first reason that MNCs are a good bet is that they fall lesser than the market during corrections. We think this is an important factor to consider given the current market move.

 For this comparison, we’ve considered the Nifty 50, since it is the main market indicator.

Rolling the Nifty MNC’s 1-month returns since 2010 shows that the index captures just 80%, on an average, of the Nifty 50’s correction. That is – its decline is only 80% of the index. This is better than most multi-cap funds, and the two MNC funds (with sufficient track record as MNC funds) have fared even better. If this period is stretched out to 1 year, the Nifty MNC ‘s fall during market correction was just 26% of the Nifty 50.

But given that MNCs aren’t always large-cap, we also looked at performance against the Nifty 500. The table below shows how the three indices compare in loss-making periods.

This trend is thanks to the relative ‘quality’ aspect that most MNCs have.

• For one, they are low on debt; the average debt-equity ratio of stocks that make up the FMCG index is just about 0.11.
• Two, most are characterised by high ROEs, with the average ROE at a good 23%.
• Three, dividend payouts are also higher for most MNC stocks – the Nifty MNC TRI has a better consistency than the Nifty MNC. Half the stocks that make up the current index have average dividend payouts of at least 40% over the past 5 years.

Therefore, MNC as a theme can counter market slides and help limit returns slide in your portfolio during tough markets.

MNCs beat the main market indices

The Nifty MNC TRI’s average returns across timeframes score better than the Nifty 50 and the Nifty 500 by a good margin, thanks to its ability contain downsides better.

Consider the period from 2007 to date – we chose this since it covers multiple market ups and downs. The Nifty MNC delivered an average return of 15.5% on a 5-year basis. That’s significantly above the Nifty 50’s 10.4% and the Nifty 500’s 11%. This wide differential persists even over a longer 7-year period.

Along with better performance on an average, the Nifty MNC does better than the Nifty 50 and the Nifty 500 with a reasonable degree of consistency. Rolling 1-year of the three indices since 2010 has the index beating the Nifty 50 a good 63% of the time. On 3-year return in the same period, the Nifty MNC beat the Nifty 50 close to 90% of the time.

So unlike most other themes, you can hold an MNC thematic fund as a theme for the long term. You don’t need to time entry and exit as volatility evens out over the years and returns hold above the broad market.

Sector and stock exposure can be very different

MNC as a theme is diverse enough to encompass both consumer-driven as well as cyclical businesses. But the stocks through which the theme is played sets it well apart from most diversified equity funds.

First, there is a very low share to financials. A third of the Nifty 500 is in banks and financials. Given the dominant exposure, large-cap and multi-cap equity funds will also have sizeable finance exposure. But MNC options in this space is mostly insurance companies and AMCs.

Next, the MNC index and MNC thematic funds also tend to have higher allocation to other stocks compared to more diversified funds given that the field is limited. An Mphasis or Honeywell Automation or Cummins India, for example, may not account for big shares in diversified equity funds but will find good weights in MNC funds. Similarly, stocks such as Britannia Industries or Nestle India are the top weights in MNC funds unlike other equity funds.

This means that you can get a thematic fund play that is different from the large-cap or multi-cap funds that typically make up the bulk of your portfolio.

Using MNC funds

Let’s look at the caveats to the performance figures above.

• A big part of the performance has come in since 2013, a good chunk of which is due to the index being FMCG-heavy. The sector’s weight has tended towards upwards of 30%, featuring HUL, Britannia, GSK Consumer, and Colgate Palmolive – all strong gainers. Until the index methodology changed in 2018, Maruti Suzuki, another star performer, accounted for around 20% or higher of the index.
• Second, the lack of finance exposure means that the MNC theme can fall back if the market tide turns towards the sector.
• Third, given that there are plenty of opportunities outside MNCs, diversified equity funds can still deliver better. For instance, consider Kotak Standard Multi-cap, Canara Robeco Equity Diversified or Mirae Asset Large Cap – all quality funds part of Prime Funds. Rolling 3-year returns over the past 5 years has the MNC funds beating them about 60% of the time. So there’s enough probability that diversified funds can deliver better. Parag Parikh Long Term Equity soundly beats the MNC’s ability to contain downsides.

So what should you do?

• Use MNC thematic funds to bring in differentiation in your portfolio only. You can skip it altogether as it is not a portfolio must-have, and if you hold investments such as the Nifty Low Vol 30.
• Keep allocation up to 10-15% of your portfolio. This allows the fund to contribute to your portfolio without dominating it. It suits any risk profile.
• If your invested amount is small, avoid adding diversifiers such as UTI MNC. It’s best to build up investments in your existing diversified equity and debt funds first. Ensure that your fund style-mix is enough to manage market cycles.
• As with any equity funds, they require a 5-7 year holding and do not need timing like other theme funds. MNCs as a theme always look expensive; valuation alone may not be the metric to gauge this theme.

Which MNC fund to invest in?

No, we’re not yet at the end! There’s still the matter of which MNC thematic fund to go for. Of the 4 MNC thematic funds – one (SBI Magnum Global) shifted from being a mid-cap fund to an MNC theme in 2018’s re-categorisation. The other, ICICI Pru MNC, was launched only in 2019. So that leaves funds from Aditya Birla Sun Life and UTI.    Our preference is UTI MNC.

UTI MNC has been steadily gaining ground over the past six months. On a 1-year rolling return basis since 2010, UTI MNC beat the Nifty MNC TRI 63% of the time and ABSL MNC 48% of the time. On a rolling 3-year return for the same period, UTI MNC beat the index 70% of the time, on par with ABSL MNC.

Next, UTI MNC has a far lower volatility than either peer or the index. It both falls lower and rises lower, but still delivers well over the long term. Its average returns across timeframes are above the Nifty MNC by a margin of two percentage points or more. On Sharpe ratio, UTI MNC scores above ABSL MNC.

UTI MNC follows a buy-and-hold strategy; its portfolio churn is less than 15%. Stock changes are usually gradual and there are not many, or quick, entry and exits. The fund juggles around with stock exposures to book profits, or add exposure while also making some exits.

For instance, it has pared exposure to HUL and Colgate Palmolive through this year. It exited Blue Dart Express and Ashok Leyland. It cut back on United Spirits early on but has since added back exposure given the steep stock correction. It has made other timely calls such as adding Abbott India last year, and piling up on Nestle India and Ambuja Cements.

Its current portfolio is spread across sectors – both defensive and cyclical. This gives it a balance to capture different opportunities, based on where market moves now. The defensive tilt can help should markets correct now while the industrial and engineering picks can help if there’s an economy-driven revival in these pockets.

Swati Kulkarni is UTI MNC’s manager. The fund has an AUM of Rs 2,137 crore.