Equity mutual funds (MFs) are now a popular investment vehicle for investors because of poor show by other assets, with the exception of gold, in the last 5-6 years. However, gold is a pure play capital asset and it doesn’t provide any yield or interest on the initial investment.
In contrast, most top stocks pay annual dividends to investors. And equity mutual funds are a convenient means for investors and savers to take exposure to equity. The process has been aided by a massive investment in the mutual fund industry in marketing and distribution.
Historically diversified mutual funds were the default port of call for investors and the industry.
However, the category is facing a mini crisis as most of the large diversified equity funds have underperformed their benchmark like BSE Sensex and NSE Nifty 50 index. Their underperformance has been really stark during the COVID-19 pandemic.
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This is largely because the market has become highly polarised in the last six months. Reliance Industries alone accounts for nearly 30 percent of the rise in Nifty 50 index from March lows and two-thirds of all returns in the last six months has come from six 6 stocks.
Diversified mutual funds, however, by definition invest in a diversified portfolio containing dozens of stocks so as to minimise downside risk from any particular stocks. The industry regulator Securities and Exchange Board of India (SEBI) also caps the maximum exposure of a fund in a particular stock.
This is pushing investors to sector-specific funds. For example, the last six months have been one of the best periods for Pharma or IT & Technology Funds. The period also saw the rise of index funds whose portfolio mimics the composition of benchmark indices such as Sensex or Nifty. Till a few months back, index funds and other such passive funds were a niche category in India as actively managed funds usually did better.
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The sectoral and thematic funds may provide superior returns in the short-to-medium term but they are very risky. A big negative news in one top stock in that sector or a global development in that sector can wipe-out years of gains in a matter of weeks. In comparison, returns in diversified funds are much less dependent on a particular stock or a sector.
There is now a similar risk in index funds due to the ever-growing weightage of top stocks. The top 5 stocks now account for 45 percent of the combined market capitalisation of all 50 stocks in the Nifty 50 index. Five years ago, the share of top five stocks was only 29 percent. Even worse is that top 3 stocks now account for nearly 35 percent of the index market capitalisation against 19 per cent five-years ago.
What this means is that a big negative development in any top stocks could translate into a sharp correction or volatility in the index and the index funds that mimics it. Given this, diversified equity funds provide the best risk reward ratio to investors even if they underperform in the short to medium term.
We have made the task easier for you by curating the list of the top 10 diversified equity funds. We have selected these funds on the basis of the consistency in their returns since their inception. Our analysis only includes funds with assets under management (AUM) exceeds Rs 500 crore or more. Data has been sourced from ICRA Analytics Mutual Fund India.
To arrive at the list, we analysed the returns of all 120 diversified equity funds that meet the AUM threshold on six-months, 1-year, 3-year and 5-year basis and since their inception. Then we looked at the variance in their short-term and longer-term returns from average returns in the last 5 years.
Finally, they were ranked on their return consistency and its variance to get a list of funds that offer returns with least volatility over a 5-year period.
It's best to spread your money over at least 5-6 funds. And lastly, do consult an investment advisor before putting money in any of these funds. Happy Investing.
(Karan Deo Sharma is a Mumbai-based finance and equity markets specialist).
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