AUTHOR: Rama Krishna Vadlamudi vrk_100@yahoo.co.

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November 10th, 2006

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 The Mutual Fund Industry has grown by manifold in the last three to
four years. As per the latest available statistics, Assets Under
Management of MFs in India is more than Rs 3,00,000 crore. The number
of Fund Houses is about 30 and these Fund Houses have floated a
number of schemes over the years. The number of fund schemes, at
present, is about 700. The types of schemes range from well-diversified,
debt, balanced, equity, large-cap oriented, mid-cap oriented, theme-based,
index, MIP, G-Sec, sector-based ones to equity-linked savings schemes.
This bewildering array of schemes often leads investors to opt for schemes
which seldom meet their investment objectives. Many a time, there will be
a huge disconnect between what the market sells aggressively and the
kind of scheme that best serves the real interests of the investor
concerned.

HOW TO CHOOSE AN EQUITY MUTUAL FUND

Before investing in an equity mutual fund, it would be better if investors take a

hard look at the following four parameters:

1. SUSTAINABLE PERFORMANCE: It is always safe and better to choose

a fund which has a well-established track record of at least three to five
year period. The comparison of over a longer period gives the investor a
better perspective with regard to the ability of the fund to ride any bear
phase in the stock markets. Several funds do well in certain time periods
and fail miserably in other time periods. For example, HDFC Capital
Builder was doing well till 2005. But in the last six months, its performance
had dropped and the fund is an underperformer of late. Its present rank,
on a one-year scale, is 120 out of a total of 135 diversified equity funds
(source: Mutual Fund Insight). In contrast, HDFC Top 200 has given
superior performance in bear phases as well as bull runs since its launch
in 1996. In addition, one needs to compare the fund’s performance with
the benchmark index. Every fund would have a yardstick, called
benchmark index, against which it requires to be measured. BSE Sensex
is the benchmark index for Tata Select Equity Fund, Templeton India
Growth Fund, DSPML Opportunities Fund. Funds, like, Tata Index Fund,
Sundaram Select Focus and Reliance Growth are benchmarked to S&P
CNX Nifty. One also needs to use the performance comparison with
funds of similar objective. For example, Birla Sun Life Equity fund is a
large-cap oriented one and the major portion of total assets is in large-cap
stocks. The fund’s performance is to be compared with other funds, that
have large-cap orientation, like, Tata Pure Equity, Principal Growth, etc.
Likewise, Birla Mid-cap, a Mid-cap oriented fund is required to be
evaluated in relation to other Mid-cap funds, like, Franklin India Prima,
Magnum Global, etc.

Rama Krishna Vadlamudi, MUMBAI. vrk_100@yahoo.co.in. Nov. 10th, 2006 Page 2 of 9

 2. SUITABILITY: Almost all investments have a certain degree of risk
attached to them. Risk appetite differs from person to person. In general,
the degree of return is in consonance with the amount of risk taken,
provided the investment is well managed by the investment manager.
Some funds take higher risk than other funds. That is why it is important to
know whether the fund is sticking to its objectives. Investors need to be
aware of their investment objectives before they select a particular type of
scheme. For example, Sundram Rural India Fund invests in companies
that are focusing on Rural India. HDFC Top 200 states its objective as
generating capital appreciation from stocks in BSE 200 Index. Let us
suppose, an investor who has a low risk appetite and who wants good
long term returns, should avoid investing in mid-cap funds, like Sundaram
Select Midcap or Birla Midcap, who predominantly invest in mid-cap
stocks and churn their portfolios in an aggressive manner. Mid-cap stocks
are considered more volatile than large-cap stocks. In bull markets, mid-
cap stocks outperform large-cap stocks, however, in bear markets, mid-
cap stocks fall much more heavily than large-cap stocks. If one looks into
the portfolio of the fund, one can have a better idea of stocks and sectors
that the fund is invested in. The portfolio of stocks can be compared over
different time periods.

3. FUND MANAGER’s TRACK RECORD: Equity Fund Managers, like,

Prashant Jain, K N Siva Subramanian, Sukumar Rajah, Anoop Bhaskar,
Sandip Sabharwal, etc., have rewarded investors with excellent returns
through funds managed by them. It is the ability of the fund manager to
foresee the trends much earlier than others that sets them apart in the
crowd. Fund management requires real talent, creativity and sharp focus
with a keen eye on market dynamics. Dhirendra Kumar, CEO, Value
Research, says, “The continuity of fund managers is important. It is not a
coincidence that in some of the great performing funds in the country over
the past ten years, the common element is continuity of fund manager.”
Prashant Jain (HDFC Mutual Fund) looks for sustainability. His biggest
success thus far has been his call on technology in 1999. Jain sensed the
fall six months in advance and sold off tech stocks from his portfolio.
Sanjay Dongre (UTI Mutual Fund) picks stocks which exhibit high growth
visibility. He has consciously avoided metal stocks. K N Siva Subramanian
(Franklin Templeton) looks for companies with quality management. He
follows a blend of growth and value style of investing and holds to his
stocks for long term. He says, “If the management and business are good,
one can hold on to a stock even if the stock valuations run ahead of
fundamentals for a while.” Contrastingly, Anoop Bhaskar (Sundaram
Mutual Fund) makes money by selling stocks when they have reached
their peak rather than holding on to them for long. He opines, “There is
nothing called long-term investing. We identify stocks with a questionable
management and low institutions holding. It may be futile to attach too
much importance to corporate governance.”

Rama Krishna Vadlamudi, MUMBAI. vrk_100@yahoo.co.in. Nov. 10th, 2006 Page 3 of 9

 4. DIVERSIFICATION: Mutual funds are supposed to have a well diversified
portfolios. But, sometimes, it so happens, that the funds are heavily
concentrated in a particular sector or a stock, exposing the investors to
higher risk. Kotak MNC fund is having an exposure of 28 per cent (of total
assets) in Basic/Engineering sector. Any adverse and swift market
reaction to Engineering companies is likely to expose the fund to a steep
fall in NAV. Taurus Starshare Fund holds 25 per cent in Jai Prakash
Associates. This excessive concentration may jeopardize the interests of
investors, when they look for a well diversified fund. Another problem with
some funds is client concentration. It is highly likely that only a few clients
are available with funds having insignificant corpus. If a client with a higher
share of the fund exits, the performance of the fund may suffer adversely.
However, SEBI had, a few years back, taken certain measures to avoid
such client concentration. Investors need to have a close watch on any
large erosion in assets under management (AUM) of the fund. The history
of mutual fund industry reveals that there are many instances of funds
losing up to 70-90 per cent of their total assets. In such circumstances,
investors who stay on in the fund lose heavily. Over diversification is also
a problem with certain funds, like, Fidelity Equity Fund which holds more
than 120 stocks in its portfolio.

In addition to the above mentioned parameters, it is advisable to use certain

statistical measures also. (i). Beta: Beta is a statistical tool, which gives one an
idea of how a fund will move in relation to the market. Beta represents
fluctuations in the NAV of the fund in relation to market returns. A fund with a
greater value of one is more volatile than the benchmark. If a fund’s beta is one,
it indicates that the fund is closely following the benchmark. A low-beta fund will
rise les than the market on the way up and lose less on the way down. Similarly,
a high-beta fund will rise more than the market and also fall more than the
market. (ii). Sharpe Ratio: This ratio measures the amount of excess return for
each unit of risk taken by the fund. Risk in this case is taken to be the fund’s
standard deviation. Excess return is measured as the difference in return
generated by the fund and the return generated by the risk free rate of interest. A
negative excess return indicates that the fund is generating less return than the
risk free rate. A Sharpe ratio is always used as a measure of comparison
between similar funds.

Rama Krishna Vadlamudi, MUMBAI. vrk_100@yahoo.co.in. Nov. 10th, 2006 Page 4 of 9

 MUTUAL FUND MYTHS
There are a lot of misconceptions about mutual funds. Investors need to stay clear of these
myths. These mistaken beliefs often lead investors to choose funds that do not match their
intended goals. Some of the common myths are discussed below:

1. One of the most popular myths is: A fund with an NAV of Rs 10 is cheaper
than an existing fund with an NAV (net asset value) of Rs 50. The reality is
completely opposite. The structure of a mutual fund is such that an MF
does not have any intrinsic value; instead, the value of an MF is derived
from the value of investments that a fund holds. On an identical
investment outlay, we would get more units when a mutual fund offering is
priced at Rs 10 than when it is available in the market at Rs 50. But the
number of units we get, which is a function of a scheme’s NAV, is not an
indicator of how cheap a scheme is. Cheap is a function of the returns,
which can be assessed only in hindsight, never at the time of investing. A
scheme’s NAV is the market value of its portfolio at a given point of time–
and its performance is what determines the returns. Say, fund A (a new
scheme, with an NAV of Rs 10) and fund B (an old scheme, with an NAV
of Rs 50) have invested only in scrip X, which is currently quoting at Rs
150. If the scrip appreciates 20 per cent to Rs 180, the NAV of the two
schemes too would appreciate by 20 per cent, to Rs 12 and Rs 60,
respectively. In both cases, the gain, too, would be 20 per cent. So, as
investment options, both funds are the same. However, since no two
funds have the same portfolio, the returns given by them tend to differ.
Theoretically, the share price of a stock can peak, but the NAV of a
scheme cannot. That’s because the fund manager can sell the stock if he
feels it has peaked, and buy another stock that offers appreciation
potential. Thus, the key to the returns is not the number of units we get
when we invest in a scheme, but the stocks the fund chooses to invest in.
A higher NAV implies accumulated appreciation, which can be used to pay
dividends to unit holders. So from whichever way we see it, the NAV
makes no difference to returns. It is irrelevant how high or low the NAV of
a fund is. Mutual Fund schemes have to be judged on their performance.
The best way to do this is to compare returns over similar periods. Let us
examine the record of a few New Fund Offers (NFOs) against the
old/existing funds. ABN Amro Future Leaders Fund was launched in April
2006 and its NAV, as on 9.11.06, is still well below Rs 10, that is, Rs
9.829. UTI Contra was launched in March 2006 and its NAV, as on
9.11.06, is Rs 9.68. It is quite possible that these funds may do well going
forward, provided the fund manager manages the scheme in an improved
manner. Let us examine the returns from some hypothetical investments
made in the months of April and May 2006: As can be seen from the table
given below, two old funds HDFC Top 200 & Tata Infrastructure Fund
have given an annual yield of 34.68% and 33.87% respectively; whereas,
the NFOs, Sundaram Rural India and Templeton India Equity Income
have posted an annual yield of 25.44% and 21.47% respectively.

Rama Krishna Vadlamudi, MUMBAI. vrk_100@yahoo.co.in. Nov. 10th, 2006 Page 5 of 9

 Name of the fund Date of Entry Present Annual
Investment NAV Rs NAV Rs as Yield
on 9.11.06 %
HDFC Top 200 19.05.06 91.0680 106.2090 34.68
Tata Infrastructure 26.05.06 19.5608 22.6103 33.87
Sundaram Rural 19.04.06 10.0000 11.4288 25.44
India
Templeton India 20.04.06 10.0000 11.2000 21.47
Equity Income

2. Another misconception is that a good fund manager will beat the market
year after year. Mutual Fund performance is prone to market risk. The
fund manager’s performance depends on the market fluctuations. If the
fund manager is creative and talented, he/she will be able to select the
right stocks and give good returns to investors. However, if the stock
selection is wrong, the scheme will underperform the market. Indian
Mutual Fund industry is awash with such underperforming funds. Some
fund managers churn their portfolios excessively. This excessive churn
may result in under performance of the fund, because, mutual funds
involve some costs, like, brokerage, STT and operational costs. Besides,
investors have to bear other expenses, like, entry load, exit load, recurring
expenses and initial issue expenses. Six months ago, SEBI disallowed
open-ended mutual funds from charging and amortizing the initial
expenses. Rather, funds will have to meet the issue expenses from the
load itself. Now, if we want to exit from an NFO, the funds are charging
exit loads to the extent of about three per cent, which is very high in the
short-term. Moreover, many fund houses are introducing exit loads even
for investments of Rs 5 crore and above for several of their schemes. For
example, Franking Templeton is introducing exit load for several of its
schemes. Such exit loads help in deterring the funds and investors from
excessively churning their investments.

3. One more popular belief, propagated in the halcyon days of US-64, was
that the capital of and return from mutual fund are protected and assured
respectively. After the debacle of US-64, it dawned on the unit holders that
there is no guarantee of capital and returns in mutual funds. Mutual funds
carry various risks, like, market risk, liquidity risk, excess
diversification/over diversification risk, etc. For instance, unlike bank
deposits, our investment in a mutual fund can fall in value. There are strict
norms (by SEBI) for any fund that assures returns and mutual fund can
not issue any guarantee for returns or capital. This is because most
closed-end funds that assured returns in the early-nineties failed to stick to
their assurances made at the time of launch, resulting in losses to the unit
holders.

Rama Krishna Vadlamudi, MUMBAI. vrk_100@yahoo.co.in. Nov. 10th, 2006 Page 6 of 9

 WHEN TO SELL AN EQUITY MUTUAL FUND
In equity investment, the decision to sell is more important and crirtical
than a buy decision. The same can be applied to equity mutual funds. Before
selling, it would be better if we take a considered view of individual stocks in the
MF. All mutual funds are subjected to a little underperformance in certain
periods. But such underperformance, if it is not very severe, is only natural. A
close scrutiny of the performance, for the past six to seven years, of mutual funds
suggests that some fund may show average performance for certain quarters,
but they will bounce back and give good to excellent performance after the lean
period. Several studies the world over indicate that buy-and-hold strategy is the
easiest and most effective strategy on a historical basis. What buy-and-hold
really means is staying the course through short-term dips. However, when
individual funds fail to measure up to market or peer performance from time to
time, one should consider selling. If investors weed out the such under
performing funds on a constant basis, they will be awarded with much better
returns on their overall portfolio. Some funds remain at the lowest rung for
several quarters, such funds are to be discarded immediately. Evaluating fund
performance on a regular basis is the first step for arriving at the critical sell-
decisions. When evaluating performance, it is necessary to make sure that one
compares a fund with the most appropriate peer group.

WELL-KNOWN DIVERSIFIED EQUITY FUNDS

There is a need to build a good Mutual Fund portfolio, subject to prudential
norms, for future/long-term. Some investors are comfortable with short-term and
some are happy with long-term investments. It is perilous to judge funds purely
on short-term returns basis that they have generated in the kind of bull-run that is
currently going on. Serious investors generally avoid sectoral funds. Usually, well
diversified funds form the core of investors’ portfolio. Based on the comfort level,
we can build a good portfolio in measured steps and monitor the portfolio
performance on a regular basis. The following are some of the well diversified
funds that have weathered several bear periods as well as bull phases:
1. HDFC Equity Fund: Steady returns for the long term investor
HDFC Equity Fund has got a large-cap tilt. It finds a place in the core
portfolio of many smart investors. For more than a decade, the fund has
weathered different phases in the market with aplomb and delivered attractive
value to long term investors. The consistency in performance across quarters is a
comfortable factor. Investors are also comfortable about its ability to sail through
any sluggish market phase. HDFC Equity has not only outpaced the indices, but
also a host of peer funds. The fund has got a well diversified portfolio. The fund is
appropriate/suitable for investors looking for a long term option with a large cap
tilt. The fund was launched in January 1995. In the last five years, it has given a
CAGR of 55.20 per cent. The fund manager is Prashant Jain.

Rama Krishna Vadlamudi, MUMBAI. vrk_100@yahoo.co.in. Nov. 10th, 2006 Page 7 of 9

2. Franklin India Bluechip Fund: A trustworthy fund with a good fund
manager

It is an open-ended diversified (large-cap oriented) fund launched in 1993.

It aims to provide medium to long term capital appreciation. The fund has got a
good track record. Total Assets under management are Rs 2,420 crore. The fund
takes concentrated exposures to large-cap stocks. It is one of the most
trustworthy funds. After lagging behind its peers in 2005, the fund has clawed its
way back. The fund has sustained good performance during bull phases as well
as bear markets. The fund’s hallmark is its consistency. Mr. K N Siva
Subramanian is fund manager since the inception of the scheme. Its benchmark
index is Sensex. In the last five years, it has given a CAGR of 49.7 per cent.

3. Tata Pure Equity fund: It is an open-ended diversified (large-cap oriented)

fund launched in 1998. It aims to provide income distribution and/or medium long
term capital gains while at all times emphasizing the importance of capital
appreciation. The fund has got a good track record. Total Assets under
management are Rs 307 crore as on 31.03.06. The fund has sustained good
performance during bull phases as well as bear markets. Slowly but steadily, the
fund is emerging as one of the better options for equity fund investors. Its
investment canvas is wide as it can invest both in large as well as mid-cap
stocks. This fund is in the habit of going against the crowd if it is convinced about
an investment idea. Mr. M.Venugopal is fund manager of the scheme. Its
benchmark index is Sensex. In the last five years, it has given a CAGR of 47.2
per cent.

4. Reliance Vision Fund: It is an open-ended diversified fund launched in 1995.

Its Top five holdings are Siemens, Grasim Industries, Divis’ Labs, Reliance
Communications and Indian Hotels. The fund manager is Ashwani Kumar. Its
total assets (AUM) are Rs 1,960 crore. By shuffling its portfolio between large
and mid cap, this fund has earned handsome returns for its investors. Astute
stock picking is the hallmark of this fund. It does not hesitate to try untested
stocks. In the last five years, it has given a CAGR of 66.5 per cent.

5. HSBC Equity: It is an open-ended diversified fund launched in December

2002. The fund managers are Mihir Vora and Jitendra Sriram. The top five
holdings are Infosys, Reliance Industries, Satyam Computer, ONGC and BHEL.
It has got an excellent blend of large and mid cap stocks. It follows a top-down
approach and takes sectoral calls. Within the sector, it carefully picks stocks with
strong fundamentals. It has been able to negotiate the first market decline of its
life quite well. The total assets are Rs 1,028 crore. In the last three years, it has
given a CAGR of 51.3 per cent.

Rama Krishna Vadlamudi, MUMBAI. vrk_100@yahoo.co.in. Nov. 10th, 2006 Page 8 of 9

6. DSPML Equity: It is an open-ended diversified fund launched in April 1997.
The fund manager is Apoorva Shah. The total assets are Rs 635 crore. Its top
five holdings are: Larsen and Toubro, Reliance Industries, Grasim Industries, SBI
and Hindustan Lever. The top three sectors are Technology, Diversified and
Consumer ND. In the last five years, it has given a CAGR of 48.9 per cent.

7. Franklin India Prima Plus: It is an open-ended fund launched in September

1994. Its total assets are Rs 705 crore. Its top five holdings are Grasim
Industries, Infosys, MICO, Larsen and Toubro and Bharti Airtel. The top three
sectors are Diversified, Financial Services and Technology. The fund has got no
capitalization bias, meaning it moves from large cap stocks to mid cap stocks
and vice versa, depending on the market conditions. It has got a fine blend of
large cap and mid cap stocks. The fund managers, Sukumar Rajah and Satish
Ramanathan are well experienced. In the last five years, it has given a CAGR of
49.2 per cent.

8. Birla Sun Life Equity: It is an open-ended fund launched in August 1998. Its
assets under management are Rs 406 crore. Its top five holdings are Infosys,
Crompton Greaves, Siemens, SBI and BHEL. Its top three sectors are Financial
Services, Basic/Engineering and Technology. It is one of the better funds in this
category, its investments span across large and mid-cap stocks. With stock bets
ahead of the others, it has done quite well. After being acquired by Birla Sun Life
in late 2005, the fund has stayed the course. In the last five years, it has given a
CAGR of 53.4 per cent.

* sources: web sites, newspapers, magazines, etc.

Rama Krishna Vadlamudi, MUMBAI. vrk_100@yahoo.co.in. Nov. 10th, 2006 Page 9 of 9