The Risk-Return Equation

To figure out how risk affects return, we studied the performance of open-end funds (only growth options) over a three-year period to June 30, 2001. Funds with life less than one year, and those that have been inconsistent in declaring their Net Asset Values (NAVs) have been excluded.

''My Mantra: Safety,  Return And Liquidity''

SASHI KRISHNAN, Investment Strategist, Cholamandalam AMC As the manager of a money market fund, Krishnan's challenge is fundamental: try and eliminate the interest rate risk faced by a debt investor. Therefore, his focus is on generating reasonable returns and safety. Providing investors with superior liquidity is equally important to Chola. ''We invest in put and call options mostly of around 29 days, where the interest rate risk is quite low,'' says Krishnan. The fund's strategy, however, is driven by its investor profile. It has institutional and high-value investors, who seek a low-risk, high-liquidity option to park short-term surplus funds. The fund invests in a well-diversified and highly liquid portfolio of money market instruments, G-secs, and corporate debt. ''We as such avoid gilts, since the idea is not only to give returns, but also to cover interest risk," says Krishnan. As the numbers show, Krishnan's strategy is more than working. -Shilpa Nayak

The top performer for the three years out of the 33 debt funds studied on a risk-return measure is Chola Freedom Income Fund. It has no exposure to equity and has invested in primarily good quality corporate debt. The fund has an average life of 32 months (as on June 29, 2001). The other top pure debt fund is again from the Chola family, Chola Triple Ace, which has been performing with fair consistency over the past years. The fund has a life of about 32 months (as on June 29, 2001), and its entire corpus is spread across AAA, P1+ or Sovereign-rated securities.

Among the star funds for the quarter are gilt funds that have generated astronomical returns (well, relatively) over the last few months. The risk taken by them is very little, with default risk being near zero, especially in the government securities these funds invest in. We analysed 25 schemes (only growth options) and each of these had posted positive returns. The leading gilt fund was Zurich India Sovereign Gilt Saving, which has invested in treasury bills of the government, with some allocation to the money market.

What's notable about gilt funds is that while long-dated funds have performed better in terms of returns, the shorter-maturity funds have fared better on the risk front. You don't need to be a fund manager to figure out why; it's just that longer duration securities carry with them a higher level of perceived risk and uncertainty.

The fact that market is rarely wrong in balancing risk with return is proved by the way Liquid and Money Market Funds have performed (decently) over the past three years. For an example, look at UTI Money Market Fund (MMF). It has major investments in convertible debentures of ICICI, apart from call deposits and debentures of several other corporate houses. The fund saw more than a 100 per cent rise in its size between March and April, and to take care of the excess inflow, it reoriented its portfolio to include government securities.

Prudential ICICI Liquid Plan, the number two liquid money market fund, too has about 40 per cent exposure to non-convertible debentures and bonds. But in comparison to the UTI MMF, it has more exposure to call money and repos, which accounted for a third of its portfolio in May. Besides, it had an average life of two months and 17 days (as on June end), and its rating profile includes 100 per cent investment in aaa-rated instruments.

Equity Isn't Quite Evil

With debt keeping the cash register ringing over the last few quarters, one might be tempted to conclude that debt is superior to equity in terms of return potential. Dear investor, it is not so. For, historically, equity has outperformed debt, although the associated risk has been higher too. Given equity's volatile nature, a good investing strategy would involve looking at a long-term horizon. If you can't stay invested for that long, may be you should look elsewhere.

"We Stick To Market Leaders"

J.VASWANI:  Fund Manager, JM Balanced Growth Fund The objective of the JM balanced fund, says its manager, Jyoti Vaswani, is to provide steady current income as well as long-term growth of capital. It is an open-ended income-cum-growth fund with two plans: dividend plan for regular income and growth plan for capital appreciation. Vaswani makes it point to keep her portfolio diversified and invest only in market leaders among the chosen sectors. The industries that the fund has invested in are well spread out, and stocks are held equally across both old economy and new economy companies. In these range bound markets, the fund prefers to remain proactive, and book profits if the returns top 20 per cent. That's because, as Vaswani explains, there are enough opportunities to re-enter, the universe remaining the same. In the debt segment, which accounts for almost half of the fund's portfolio, JM sticks to AAA-rated instruments and government securities. -Shilpa Nayak

Among equity funds, we analysed a total of 98 schemes (again, only growth options). The findings were interesting: While most equity-oriented funds had lost in absolute terms for the quarter, on a risk-return parameter, as many as 75 had been in positive territory over the three years ending June 30, 2001.

The top diversified equity performer for the period has been Tata Pure Equity Fund. In keeping with the category trend, Tata Pure has gradually reduced its exposure to the tech sector, while increasing its investments in old economy stocks. What this points to is not just an acknowledgement of investor concern (in terms of return volatility), but also the need to play it conservatively when the going gets tough.

The best open-end equity-linked savings scheme (ELSS) of the past three years was Zurich India Taxsaver, which has continued its good showing despite the adverse market conditions. The fund has maintained a very diversified portfolio, which is spread across technology, pharma, cement, and even capital goods. The result: lower volatility. Tata Tax Saving Fund follows an even more conservative strategy. It has very little exposure to the now-infamous ICE stocks, and has dug its fingers into old economy scrips such as Larsen & Toubro, State Bank of India, and Hindustan Petroleum.

A Mixed Bag

For all the hype and hoopla associated with sector funds, most of them have generated nothing but negative returns (absolute) over the last one year. Yet, if you took into account the associated risk, it could be said that the sector funds haven't done too badly; in fact, some sector funds have even outperformed the market.

The top performer for the three years ending June 31, 2001 was UTI Growth Sector Fund (Services), which not only picked its stocks with care, but also stayed put in the face of market jitters. It has a judicious mix of scrips from the tech, banking, and hospitality sectors, which have been performing reasonably well (at least for the fund).

In comparison, balanced funds should fare better, because they stand to gain from equity as well as debt markets. However, the poor stockmarket conditions have forced most balanced funds to increase their focus on debt instruments. On a risk-return framework, we tested 24 funds (growth options only) and most of them had outperformed the market.

Alliance 95, for instance, not only beat its competitors such as Tata Young Citizens Fund and Canpremium (RO), but stayed ahead of the market too. Although Alliance 95 continues to have a sizeable exposure to equity and investments in the ICE sectors (accounting for more than a fifth of its total holdings), its performance has justified the risks taken. The fund has diversified its portfolio and included some relatively less edgy, old economy stocks to counter the ICE volatility.

What about the index funds? Well, they have been performing just as expected-in tandem with the equity market benchmark they follow. But right now there is a dearth of such funds, and while some AMCs are expected to launch a few, it would be some time before there is a number big enough to allow comparisons.

Meanwhile, if US 64 has given you a bad case of mutual fund indigestion, may we suggest that you be patient. For one, although the finance ministry has said no to a bail out, some kind of a scheme to keep US 64 liquid will be introduced. But more importantly that the next time you sign up for a fund, make sure it has a healthy dose of debt in it.

Take the US 64 as an example. The UTI was wrong in projecting the scheme as a safe fixed-income scheme, against its nomenclature of balanced scheme with 70 per cent in equity and 30 per cent in debt. The question to ask, as an investor, is how can such a scheme keep generating fixed returns?

Besides being thought of as a fixed-income scheme, US 64 came to be looked upon by corporates as a good vehicle for short-term investments. Why else would corporates invest large sums of their surplus funds in the scheme? Worse, the UTI never discouraged such inflows. Rather it only made things worse by not addressing the problems promptly. But in a strange way, the UTI may have actually helped the industry by making investors, and fund managers, more alert. Small mercy, you say?  

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