Quarterly review – Which fund ratings have changed in Prime Ratings?

It’s the end of our second review cycle, for the April-June 2020 quarter. The updated ratings have now been published. So we’d like to highlight some trends we’re noticing in fund performance, changes in some key fund ratings and why they happened. We’ll be discussing only those categories/funds which need a mention in terms of significant changes.

Before we move into discussing the changes, please not the following:

• Our fund ratings should not be construed as a recommendation. They simply tell you where your funds stands vis-à-vis peers and whether there is any improvement or slippage I the fund’s performance.
• Our MF Review tool is our recommendation of  buy/hold/sell on funds. This looks at both quantitative and qualitative factors. We have updated our Review tool. We will be covering key changes in our review this week.

Briefly, some broad trends we’re seeing during our ratings review are:

• Some large-cap funds are closing the gap with the Nifty 100 TRI or moving above it in the past couple of months, owing to their ability to contain downside better.
• Value funds saw a turnaround as some of their value picks moved up after the March nifty correction and recent rally.
• Among hybrid funds, aggressive hybrid funds are becoming less consistent in performance with funds moving up or moving down in ratings but unable to sustain such moves. Dynamic asset allocation funds have begun using derivatives to good effect.
• Money market funds, which had come to the top as CPs and CDs saw coupons move up earlier, are now giving way to ultra-short/low duration funds as their holdings are now assimilating lower rates.
• Credit risk remains masked in many funds as fund returns have been strong with no credit event impacting performance. Risks are now also taking the form of higher concentration in some funds as they dealt with increased redemption in the past 3 months.

Large-cap funds

That this category is struggling to beat the Nifty 100 index is not new. However, the market crash earlier this year saw many large-cap funds contain losses better than the index with the result that some funds have seen their returns catch up with the index. Whether this trend sustains needs to be watched in the coming quarters.

Improved ratings: Among funds, Canara Robeco Bluechip moved up another notch to a 4.5 rating; the fund rating scored a 3 star in the December quarter. From lagging the Nifty 100 TRI, the fund has been beating the index from late 2019 onwards. Lower-than-average volatility and better-than-average alpha also helped. BNP Paribas Large Cap is another fund that has managed to climb back from a steep lag, moving now to a 3.5 star rating.

Falling ratings: While some funds saw their fund ratings change, the earlier large and popular funds are still languishing. These funds continue to underperform, and showcase higher volatility and poor downside containment, even as the ones mentioned above moved forward.

Aditya Birla SL Frontline Equity slipped further to a 1.5 star rating, to join Franklin India Bluechip. SBI Bluechip dropped from a 3 star rating to 2.5 stars, along with Nippon India Large Cap which is now 2.5 star from 4 stars in December 2019. HDFC Top 100, which had held above 3 stars earlier has however slipped to 2 stars.  

Focused funds

We rate focused funds based on their overall market cap tendencies/ mandate as either large-cap or multicap. These funds have shone in the multicap rating set as several have moved up in the ratings. Several funds from this category, that were lagging the Nifty 500 TRI last year, have bounced back better than other diversified peers. Their strategy of focusing only a handful of stocks, and ability to quickly shift around holdings appear to have helped them counter the market fall.

Improved ratings: Motilal Oswal Focused 25 moved to a 4 star rating, on improving consistency and downside containment. Similarly, Principal Focused Multicap rose a notch up to 4 stars, reflecting an improving performance. SBI Focused Equity moved to a 5 star rating as it quickly shifted to large-caps to stymie market fall, and it kept risk-adjusted returns well above average.

Value funds

As with focused funds, we club value funds based on portfolio orientation into the relevant market-cap category. Currently, value/contra funds are rated along with multi-cap funds in order to correctly gauge performance. And value funds look to be making good some of their miserable performance. Here, we’re referring to SEBI-defined value category funds plus those belonging to multi-cap and other categories, but which follow a value approach.

In the past three months, with sectors such as pharma, auto, and cement doing well, value funds which had latched on to these beleaguered sectors have done well. The recent market rally has also been relatively broad-based, picking up many individual stocks.

Having said that, very few value funds have moved up in our ratings. This is because other funds such as focused or those with blended strategies too kept up performance. The result is that the relative fund ratings for most value funds have more or less stayed where they are.

With sectors such as pharma, auto, and cement doing well in the recent market rally, value funds which had latched on to these beleaguered sectors have recouped some of their performance lag.

Even so, that value funds have begun to recover lost ground and have participated well in the market does offer comfort. It also reinforces the need to have different style blends in a portfolio; should value cement a comeback and growth stay put, an all-growth portfolio may lose out.

Improved/stable ratings: UTI Value Opportunities was already slowly clawing back; its rating stands now at 3 stars. HDFC Capital Builder Value and Nippon India Value have held on to their 3-star rating. The table below gives other examples of funds where ratings have been stable.

Falling ratings: Funds that slipped on ratings include L&T India Value, dropping a notch to 2.5 stars. Aditya Birla SL Pure Value, already low at 1.5 stars before, went even lower to a 1-star rating.

Aggressive hybrid funds

Most aggressive hybrid funds appear to have given up their tendency to go into mid-caps and small-caps. Those that scored on containing downsides ever since the end of the 2017 bull run have remained at the top.

Falling ratings: Here, HDFC Hybrid Equity, a fund that been among the best for years has taken a blow to drop down to 3.5 stars thanks to its top few stock holdings lagging the Nifty 50, its higher-than-average volatility and poorer downside containment. Aditya Birla SL Equity Hybrid 95 fell a notch to 2.5 stars, owing to continued underperformance, higher mid-cap/small-cap share and poor risk-adjusted returns.

Debt funds with very short durations

We put several categories together when looking at very short-term debt funds – money market, ultrashort, etc. This is because portfolios and instruments they invest in are very similar and serve similar timeframes, and therefore need to be seen together.

In this set, low duration funds had rarely made it to the higher ratings as most had high credit risk. This apart, the strong performance of money market instruments post the 2018 debt credit crisis helped these funds maintain a higher rating. This is now changing with some money market funds slipping as yields drop in shorter-term commercial papers and bank CDs. Funds with short-term bonds have managed to lock into better yields and have fared better.

Fund ratings should not be the only criteria to pick funds – please use our MF Review Tool to know what to do with funds, as ratings can mask some risks in a fund’s portfolio especially in debt funds.

Improved & stable ratings: Aditya Birla SL Savings, Axis Treasury Advantage and ICICI Pru Savings have improved one notch, from 4 to 4.5 stars for the former and 3.5 stars to 4 stars for the latter two. Higher-than-average portfolio yields and improving returns have led these funds to a rating improvement.

Franklin India Savings has retained its top rating. The fund had a quality portfolio, even as other funds from the AMC took on extreme credit risk. It built up cash exposure to handle redemptions that stemmed from the closure of the AMC’s other debt funds. Its returns are still above the category average. It still has a reasonably good AUM. However, the cash build up has led to concentration in a few papers, even though these are high-quality names. We’ll cover this fund in more detail in our Prime Funds review later this week.

As we have said before, fund ratings should not be the only criteria to pick funds – please use our MF Review Tool to know what to do with funds. ICICI Pru Savings fund mentioned above, for example, has some exposure to lower-rated papers.

Short duration and banking & PSU funds

In this category, banking & PSU funds still rule the top few funds, as the yield rallies in their PSU holds help. But with short-duration funds also taking to gilt exposure to ride the rate cycle, many have kept pace and in some cases even beaten banking & PSU funds.

Improved ratings: Axis Short Term Debt has moved up from 3 stars to 4 stars over the past three rating cycles. Canara Robeco Short Duration has also moved to 3 stars from 2.5 stars. Apart from improving returns, the comparatively poorer performance of some other banking & PSU funds helped these funds kick ratings up.

Corporate bond & medium duration funds

Corporate bond funds, like short-term funds, have used the yield rallies to their advantage. Along with their better-quality portfolios, corporate bond funds beat medium-duration funds, the debt category they are comparable with.

Improved ratings: Nippon India Prime Debt zoomed to a 5-star rating thanks to a high portfolio yield, high risk-adjusted return, and improving consistency against peers. However, as said above, ratings alone can mask portfolio risks. In this case, the fund has both concentration in top papers as well as some credit risk as corporate bond funds can have up to 20% of their portfolio in papers outside AA+/AAA. Use our review tool for our calls on funds. IDFC Corporate Bond is another fund whose steadily improving performance, top-quality portfolio and deft managing of portfolio maturity has helped it climb up to a 4 star rating from 3 stars.

Falling ratings: Aditya Birla Sun Life Corporate Bond dropped one notch to 4.5 stars as Nippon Prime Debt’s higher yields and returns pushed it higher and took the ABSL fund’s place. As such, there is no change in the performance and quality of the ABSL fund. Among other funds to see a rating fall, HDFC Medium Term dropped from 3 stars to 2.5 stars while DSP Bond slid to 1.5 stars from 2.5 stars.

Corporate bond funds and short-term funds have used the yield rallies to their advantage.

Gilt funds

Constant maturity funds still score at the top for the gilt fund category. Their better returns and better consistency compared to other funds keep them at 3 stars or above. SBI Magnum Constant Maturity and IDFC G-Sec Constant Maturity hold the top 5-star spots with ICICI Pru Constant Maturity Gilt a bit further down at 4.5 stars.

AMC trends in fund ratings

Sometimes, due to process changes, fund manager changes, investment philosophy and strategy changes and the like, funds across an AMC begin to improve. We’ve begun noticing the following trends here:

• DSP AMC is seeing improvement in many of its equity funds – DSP Small Cap, for example, has steadily improved rating in the past 3 quarters. DSP Focus and DSP Equity have also improved on beating the market.
• BNP Paribas AMC’s equity funds, in the large-cap and mid-cap space, and to some extent in multi-cap are improving.
• Axis AMC’s debt funds are beginning to improve from the middle-of-the-road funds they were earlier. Some funds have already been highlighted above.
• SBI AMC’s debt funds have also tended to remain at 3 stars and above in most categories, while other AMCs have funds across the rating spectrum.

P.S: We will be writing about key changes in our buy/hold/sell recommendations, updating our fund recommendation Prime Funds, our ETF recommendations Prime ETF, and our readymade portfolios Prime Portfolios in the coming days as our review cycle completes. Please note that all the reports on these changes are available only for subscribers. More reason for you to subscribe today!