asp Risk management and the mutual funds The basic objective of a mutual fund is to provide a diversified portfolio so as to reduce the risk in investments at a lower cost. The mutual fund industry worldwide is based on this premise. Investors who take up mutual fund route for investments believe that their risk is minimized at lower costs, and they get an optimum portfolio of securities that match their risk appetite. They are ignorant about the diverse techniques and hedging products that can be used for minimizing the market volatility and hence take the help of the fund managers. It is very daunting to note that the drop in the NAV of some of the schemes is higher than the erosion of value in some of the ICE stocks. The recent survey conducted by PricewaterhouseCoopers (PWC) on risk management by mutual funds has posted interesting as well as worrying results. According to the survey, as many as 50 percent of the respondent mutual funds are not managing risk properly. If this is not all, 50 percent of the respondents did not even have documented risk procedures or dedicated risk managers. The respondents included among others, some of the heavyweights of the Indian MF industry viz. Templeton, Alliance, Prudential and IDBI Principal MF. Worrisome news it is, for the investor who still believes MFs are a route to manage one’s money in a better and safe manner. The recent wild movements in the NAVs of several equity funds have belied all expectation of a diversified portfolio from the fund managers when the basic tenet behind portfolio management is risk management. Mr. Shyam Bhat, Fund Manager-Tata asset Management Ltd. said ‘Indian Mutual fund industry is not using statistical techniques of risk management but is using diversification effectively within the market limitations. As far as use of derivatives is concerned, they are not presently used because of the low volumes, low liquidity and absence of sufficient hedging products in the market ’. Aggression has been the key word followed by the AMCs when it comes to taking positions in stocks. With investment in volatile ICE sectors being the driver of growth last season, almost everybody had taken big exposures to them. Birla MF maintained its exposures in Infosys to almost 25 percent in all of its equity schemes throughout last year. The same is true of ING Savings Trust that has Rs. 60 crores invested in Wipro and Infosys out of the total fund size of 135 crores in its growth fund. The result of these exposures is that the fund witnessed a movement of almost 9 percent in a single day on budget when the market saw an appreciation of around 4.36 percent. In their quest for growth, many funds have seen very volatile movements in NAVs. The investor confidence may not be lost but such volatility sure dents it. The point is not whether AMCs should be chastised or not but just to question the practices as the fate of many investors is linked to it. An ordinary investor considers mutual funds as the experts in investment decisions and so naturally expects the decision of investing in mutual funds to bear fruit. However, AMCs often leave a lot to be desired as they falter on important fronts like NAV and portfolio disclosure besides posting high fluctuations and poor returns.

ING Growth Portfolio (20. which is relatively high due to its exposure to two volatile ICE scrips.The Beta of some of the favorite stocks is shown below. Wipro Ltd. ING Growth has a standard deviation of 3.82 1. Dhansamridhi (9.06%).Services (9.09 2. While Alliance Equity Fund has a Standard Deviation of 2. Global Tele-Systems Ltd.02%).45%) UTI US 92 (7.48%). 2.54 As can be seen.00 Taurus Libra Leap (5.3.57. They should understand that the investors forget the high returns posted in any specific period very soon but they take hell lot of time to forget the burns they get during periods of losses.Services (7. Alliance Equity Fund (9. Taurus Discovery Stock (10. (6.81 1. Chola freedom Tech (11. Birla Advantage has reduced its exposures to Infosys drastically in the last two months and taken steps to contain volatility.5%) Himachal Communications Ltd. Birla Advantage has its Standard Deviation at 2. Similar steps are being planned by SBI Mutual Fund that is recasting its equity portfolio to reduce risks as they can scare investors.68%). Magnum Sector Fund -Infotech (15%). Infosys Technologies Ltd.5%).8%) UTI Sector. ING Growth Portfolio (3. DSP ML Tech. Futuristic 1. 1.21%).51%) IL&FS eCom (9.7%). DSQ Software Ltd. Satyam Computer Services Ltd.2%).06%) ING Growth Port (11. some of the stocks are too volatile and can cause wild movements in the NAVs of funds that have taken exposures in them. Hence for maintaining the confidence of the retail investors it is very important to .63%). The Table contains the Beta of some of the ICE scrips that constitute the top 10 holdings across various equity funds. Zee Telefilms Ltd. Alliance New Millennium (11.53.8%).98 1. ING Growth Portfolio (10.70 1.87 ING Growth (23. The standard deviation of the returns in some of these funds points to it. Alliance Alliance New Millennium (10%) UTI Sector.18%) LIC SSI Ltd. It is unfortunate that the fund managers are not taking due care for minimizing the risk and are in a race to post higher and higher returns during the phase of bull-run.

Some mutual fund houses are quite disciplined but every body should embrace the same spirit. Fund Manager . The fund manager should disclose what they are doing at the hedging front. They should come up and tell their investors as to what they do at times of high fluctuations. AMCs would do well to keep the investor and his interest in mind before taking any decision. poor servicing to clients and failure of third party service providers.Dundee Mutual Fund said ‘We are actively monitoring the market movements and taking calls accordingly. . The basic technique of portfolio management thrusts on diversification. These are also going to be crucial in a rapidly growing competitive scenario. Under this setting. Though we are presently not using derivatives for hedging of risk because of lack of depth in the market for the product. Mr. it is not just growth that should be the focus area but also better management of all risks and hence. The industry needs to revise their attitude and try to streamline their actions with their objectives. which preaches inclusion of negative beta. Bhupinder Sethi. stocks in the portfolio so as to minimize the impact of fluctuation in the market.asp Research Team. Normally it has been seen that they outperform the broad market indices during the bull-runs and under-perform the indices during the bear-phases. Source : Mutualfundsindia http://www. Diversification always has a cost and investors are willing to pay for it if it is properly There are some infrastructural problems but fund managers need to be more vigilant on the market movements.’ Poor performance.mutualfundsindia.control wild fluctuations in the NAVs. are the three major risk factors identified in the survey by PWC. but we go into cash when we see the expectations of huge corrections coming in.

html/65716a52676b796b4a4c6b4144414251? http://clk. and whether those companies exhibit growth or value characteristics. The analysis can be as simple as listing the fund and relevant indexes side by side with a breakdown by sector. the simplest way to . or the characteristics they look for in companies force them into certain industries. Sector Weights Sometimes fund managers will gravitate toward certain sectors either because they have deeper experience within those sectors. Regardless of how the information is unds/L28/1545491965/x20/Investo/IPFX901000009_250_ROS_100901/IPFX901_250_ ROS_2010-09-01. It's a good start to understand the fund's specific investment mandate. For example. for a large cap This analysis will shed light on the manager's over/underexposure to specific indexes (relative to the index) in order to gain additional insight on the fund manager's tendencies or performance drivers.investopedia.) To determine a fund's sector weight.250. the investor must compare the fund to its relevant indexes to determine where the fund manager increased or decreased his allocation to specific sectors relative to the index. </script><noscript><a href="http://ops.250/01/" target="_blank"><img border="0" src=" performance can be attributable to a mutual fund manager's superior stock-picking abilities and/or asset allocation decisions.hi. we must either use analytical software or sources like Yahoo! or A reliance on a particular sector may leave a manager with limited possibilities if they have not broadened their investment net.wi.250/01/" /></a></noscript> 1.hi. Portfolio Analysis All mutual funds have a stated investment mandate that specifies whether the fund will invest in large companies or small companies. It is assumed that the mutual fund manager will adhere to the stated investment objective.250/01/"/></a>') In this" target="_blank"><img src="http://view. read Words From The Wise On Active Management.250. <script language="JavaScript" type="text/javascript"> document.wi.write('<a href="http://ops. we'll summarize how to analyze a mutual fund's portfolio and determine whether there are specific performance drivers.250. learn more. but there is more to fund performance that can only be revealed by digging a bit deeper into the fund's portfolio over time.There are a number of attractive mutual funds and fund managers that have performed very well over both long-term and short-term unds/L28/1545491965/x20/Investo/IPFX901000009_250_ROS_100901/IPFX901_250_ ROS_2010-09-01.atdmt.atdmt.html/65716a52676b796b4a4c6b4144414251? http://clk.wi.

determine sector reliance is to place the fund's sector breakdown next to both the S&P 500 Growth Index and the S&P 500 Value Index. such as valuation. read Shifting Focus To Sector Allocation. They then perform rigorous due diligence on the companies that pass through each phase of the filtering process. size. this manager should have a bottom-up approach. or a variety of combinations of these types of factors. earnings. will have a higher weight in the S&P 500 Value Index than in the S&P 500 Growth Index. Attribution Analysis There are fund managers who claim to have a top-down approach and others that claim to have a bottom-up approach to stock-picking. (To learn more. In order to determine whether a fund manager is actually adding any value to performance based on asset allocation or stock picking. (For more insight. will have a higher weight in the S&P Growth Index than in the S&P 500 Value Index. . A comparison of the fund relative to the sector breakdown of these two indexes will indicate whether the fund is in line with its stated mandate and reveal any over/under allocations to a specific sector. (To learn more. A manager that employs a bottom-up methodology will filter the entire universe of companies based on certain criteria. Both of these indexes exhibit unique sector breakdowns because certain sectors routinely fall into the value category. read Build A Model Portfolio With Style Investing. on the other hand. known as a value sector. known more as a growth sector. Top-down indicates that a fund manager evaluates the economic environment to identify global trends and then determines which regions or sectors will benefit from these trends. If the manager's mandate describes a top-down methodology. while others fall into the growth category. on the other hand. Let's look at a five-sector portfolio as an example: In the tables below. an investor needs to complete an attribution analysis that determines a fund's performance driven by asset allocation versus performance driven by stock selection. ignores. macroeconomic factors when searching for companies to invest in. for example.) 2. this might be a cause for concern because we've discovered that the fund manager has done a poor job of asset allocation (top-down).) A bottom-up approach. growth. Using this example. we compare a mutual fund portfolio with its relevant benchmark and identify how much of the portfolio's performance was attributable to asset allocation (sector weights) versus how much was attributable to superior stock picking. The fund manager will then look for specific companies within those regions or sectors that are attractive. can reveal that a manager has placed incorrect bets on sectors but has picked the best stocks within each sector. read Benchmark Your Returns With Indexes. Industrials. Technology.) The key to this analysis is to perform it on both current as well as historical data in order to identify any tendencies the fund manager may have. Attribution analysis. for the most part.

05 Total: -2.10 0.465 Interaction -0.350 0.240 1.5 1.15 4 Sector 0.075 -0.74 1.370 -0.740 0.86 0.2 0.550 Overweigh Performance t 0.400 0.2 3.5 0.500 0.2 3.2 Contribution 1.7 6.10 -0.060 0.200 -0.2 2.250 0.0 0.5 3.300 3.0 2.05 -0.075 0.7 1.2 3.0 1.26 0.880 -0.010 -0.5 2.100 0.10 Return 4.20 0.38 Sector 0.620 -0.10 0.050 0.020 0.225 0.Portfolio -Sector 1 Sector 2 Sector 3 Sector 4 Sector 5 Total: Benchmark -Weight Return Contribution 6.30 0.3 0.055 Active Management Effect Error .030 0.225 0.415 Allocation 0.30 0.15 5 Total: Attribution -Sector 1 Sector 2 Sector 3 Sector 4 Sector 5 Total: Selection -0.83 Weight 0.10 -0.22 4.20 1 Sector 0.30 2 Sector 0.20 3 Sector 0.

88% minus the unexplained portion of -0. The second chart shows the same calculations for the relevant benchmark. • • • • • • • • Step 1: Determine the sector weights for both the fund and the index. The third chart shows the calculation of both allocation and security selection contribution. We can see from the return of 4. The last chart shows the active management effect of positive 0. We could see that the total return for the benchmark was 3.55% and that the fund outperformed the benchmark by 0. As such. Notice that the fund had a 30% weight to Sector 1 while the benchmark only had a 20% weight. the manager contribution to performance for overweighting Sector 1 was 0.Overperformance 0. The second column in that chart shows the return of each sector within that portfolio.825%.2%. Step 3: Calculate the rate of return for the fund by adding the contribution of each sector together.055.2% return.) Step 4: Calculate the overweight amount by subtracting the index weight for each sector from the fund weight for each sector. Step 6: Calculate the selection attribution by multiplying the benchmark weight with the difference in performance. As you can see. this information is very useful to determine whether a manager is driving performance through asset allocation (top-down) or security selection (bottom-up) analysis. The results of this analysis should be compared to the fund's stated mandate and . the security selection within the sector was not very good and therefore the fund only had a 4. we see the sector weights for the fund's portfolio for each of five sectors. resulting in active management contribution of 0. Step 7: Calculate the allocation attribution by multiplying the index return for each sector by the overweight amount. Step 8: Calculate the interaction by multiplying the overweight column by the performance column. Repeat for the index. and the third column calculates the contribution of each sector to the fund's total return (weight x return). the fund had a return for the period of 4.83%. In this example. Step 2: Calculate the contribution of each sector for the fund by multiplying the sector weight by the sector return. In this case.825 In the first chart. Now this might get a bit tricky: The fund manager made the correct choice of allocating to Sector 1 as the sector for the benchmark had a return of 6. however. read Benchmark Your Returns With Indexes. which resulted in a contribution of -0. Repeat for the index. (To learn more. the fund manager over allocated to this sector assuming it would outperform.4%.38%. the highest of all five sectors.2% for Sector 1 within the fund was 2% less than the return for the same sector within the benchmark.62% but the manager did a poor job of security selection. Step 5: Calculate performance by subtracting the index return for each sector from the fund return for each sector.

is president of Neto Financial Group. as well as fund managers with different levels of expertise in certain sectors. An investor can also break down the portfolio into market cap groupings and determine whether the fund manager is particularly skilled at picking companies with certain size characteristics. can provide the information required to properly construct a portfolio. although time consuming. Ideally. Whichever factor or characteristic an investor wants to analyze. an investor would want a mix of good allocators and good stock pickers.CFA (Contact Author | Biography) Arturo Neto Jr. Conclusion There are many other factors to consider when analyzing a mutual fund's portfolio. the results can provide valuable insight into a manager's skill and further enhance the investor's portfolio construction process. an investor can better understand the historical performance of the fund and how it should be used within a diversified portfolio of other funds. This type of analysis. Source: Investopedia. . by Arturo Neto. By analyzing the sector weights of a fund and the fund manager's attributions to performance..the fund manager's CFA.

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