Wise Advice

Mr. Bond's 3 wise suggestions on equity fund selection

Sunil (Mr. Bond) Jhaveri, MSJ Capital, Gurgaon

In this new series on equity investing, Sunil starts with the idea that knowing what not to do will help you win half the battle in selecting the right equity funds for your clients. His three point formula for success in equity fund selection:

1. Avoid heeding to any fund house buy calls on sectors and themes unless you are confident of timing the exit independently for your clients.

2. Avoid closed ended funds, irrespective of the argument on promoting long term investing.

3. Prefer multi cap funds over funds that invest only in one market cap segment - unless you are confident of giving independent exit calls to your clients

After broadening his expertise from bond markets to asset allocation strategies, WF invited Sunil to share his insights on equity investing in this new series. After this initial curtain raiser on what not to do, get ready for Mr. Bond's insightful data-rich perspectives in the forthcoming weekly editions of Wise Advice every Wednesday.

Vijay has asked me to pen my thoughts on different parameters for Equity scheme selections besides just the quantitative measures. Though I am not an expert on Equity Investing (though Asset Reallocation theme is now what readers relate me with; besides the Bond Markets), I will still give it a try to the best of my ability.

To start with, I thought of addressing the issue of what we as Advisors should not fail prey to & thereby narrow our Horizon of Equity Scheme selections. If we do this successfully, half our job would be done. So let us start with What Not to Do rather than What One Should Do:

1. Avoid Sectoral schemes

2. Avoid Close Ended schemes &

3. Prefer Multi Cap funds over cap specific funds

Avoid Sector Themes

Investors often get investment calls in different sectoral themes including IT, Pharma, Infrastructure, Oil and Gas, Consumer Durables, Banking and Finance. These sectors can do well for some time and go out of flavor in a few months, or years. Most times disinvestment calls are not as forthcoming as investment calls. In such a scenario, investors get stuck with these investments as they go out of flavor pretty soon.

Also, we must not forget that AMCs are just manufacturers of these schemes & asset classes. They may give an aggressive investment calls but seldom give disinvestment calls when these sectors or themes go out of flavor. It was up to us as Advisors to have consciously avoided such calls of investment & not recommended the same to our investors. If we have given investment calls in such themes; then we should be the one who should be responsible for giving aggressive disinvestment calls at right times as well. We simply cannot hide behind the excuse that AMCs had recommended investment & hence it is not our responsibility to give timely disinvestment calls.

Initially, investors feel very happy after investing in these themes or flavors as they see notional profits accruing in their investment portfolios. However, when these themes go out of flavor, same notional profits start dwindling (as profits were not booked) and many times turn to losses as investors do not disinvest at appropriate times.

Following chart of returns in SENSEX vs. some sectoral themes over a period of time will demonstrate why an investor should not have invested in these sectoral themes. A Fund Manager based on their research should have increased or decreased exposure to these sectors.

We are well aware of sector calls in Tech theme in late 90s & subsequent Tech bubble burst of 2000. Something similar happened with Realty Sector during 2006-2008 equity market boom. This sector delivered phenomenal returns during this period followed by a huge correction (which incidentally has not recovered till date).

Avoid Close Ended Schemes

Another mistake we make is investing in Close Ended Equity themes; thereby tying investor hands behind their backs. Though argument in favor of close ended schemes is that it is for the benefit of investors to stay invested for longer periods (on an average an investor stays invested in Equity as an asset class for only 1.78 years or only 2% of investors stay invested for more than 10 years); scary statistics but reality on how Investors behave & act irrationally. What if the close ended scheme was maturing post 2008 correction in the year 2009?

Invest in Multi Cap Equity Schemes

I prefer investing in Multi Cap schemes where the Fund Manager takes a call on investing in Large Cap, Mid Cap, Small Cap or in Multi Cap themes. There was a huge correction in Large Cap space due to Chinese melt down in 2015. Most Large Cap schemes corrected sharply. When markets go in a correction mode mostly the small cap space takes maximum beating. Unfortunately we have got investors used to point to point returns - post mortem of past performance. Based on the same investors pick up small cap, mid cap or large cap themes for their investments. Ideal is to let these selections be made by Fund Managers.

Hence, if you wish to narrow your scope of correct selection of Equity Schemes; first weed out themes & schemes which are not good for the Investors in the first place. If we imbibe this discipline in Investor portfolios, half our job will be done & investors will not fall prey to their own behavior & biases.

Content is prepared by Wealth Forum and should not be construed as an opinion of HDFC Mutual Fund.

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