Two Hundred and Fifty Gram Gold Bars (Photographer: Akos Stiller/Bloomberg)

The Mutual Fund Show: Here’s Why Morningstar Gave Gold Ratings To These Schemes

Morningstar Investment Adviser expects volatile markets to encourage inflows into mutual funds in the next one year.

That’s because every dip presents a buying opportunity, according to Kaustubh Belapurkar, director of fund research at Morningstar Investment Adviser. Volatility for the next one year shouldn’t be ruled out, Belapurkar said on BloombergQuint’s weekly series The Mutual Fund Show.

He outlined strategies for investors with different time horizons:

  • For conservative investors with a horizon of around five years, he said that at least 70 percent of their portfolio must be in equities, especially in large caps.
  • Investors with high risk appetite and time horizon of over 10 years could invest in small caps and mid-cap mutual fund equity schemes, Belapurkar said.
  • Those with large corpus and horizon of 15-20 years could opt for systematic transfer plans over 6-12 months, after which it could be “business as usual with systematic investment plans”.

But how do investors choose funds? Morningstar gives ratings to mutual funds in different categories. Gold funds, it said, garnered the highest analyst conviction in outperforming the peer group and benchmark in the long term on a forward-looking basis.

It’s top gold-rated funds are:

•   Large-cap:  HDFC Top 100.
•   Multi-cap: Franklin India Equity Scheme.
•   Mid-cap: Franklin Prima.
•   Small-cap: Franklin India Smaller Companies.

Watch the conversation to find how Morningstar rates mutual fund schemes:

Excerpts from the interview:

Let’s talk about HDFC Top 100 Fund. Why is it a gold-rated fund and why do you like it?

Kaustubh Belapurkar: In a large cap, just to define the category SEBI has mandated what each fund should do. A large cap will invest 80 percent of portfolio into top-100 stocks. These are bluechip companies with established businesses and clearly the less volatile among the pack. 2018 was classic case where while we have seen fall in markets, small and mid-cap funds have fallen much more dramatically than large caps. We believe that large cap should form the core part of your portfolio. How much should be allocated depends of your risk-taking ability. If you’re a conservative investor, then 70-80 percent should be large cap. If the time horizon is only around 5 years, then I wouldn’t merit going anything beyond large or the multi-caps. If time horizon increases, your risk-taking ability increases, then you can look at elements of mid and small cap which will be more volatile but will deliver higher returns over a market cycle.

HDFC Top 100 Fund is the fund managed by Prashant Jain for the longest time. It has a very good strategy going by the way he runs it. He doesn’t care about benchmarks and takes concentrated bets. We look at him as an early cycle investor. Sometimes it doesn’t play to his advantage where some stock picks were too early for the market to recognise, it hurt the performance for a while but if you look at how he has delivered performance in the long term, it's very comfortable. He is a pedigreed manager. You have to have some patience because this strategy where you will see little more volatility but looking at the style of management, he pays attention to valuation than chasing growth. He is contrarian investor and puts in some high conviction ideas. So, it's a reasonably concentrated portfolio. It will be volatile but good strategy for long term.

Gold-rated fund in multi-cap category is Franklin India Equity Fund. Why do you like this fund?

Kaustubh Belapurkar: Multi-cap category is more open-ended as the regulators define it. You can go and buy large-cap, mid-cap and small-cap stocks. There are funds which have different strategies in this space. If you look at Franklin India Equity which is managed by Anand Radhakrishnan, with a tilt towards the large-cap side. Anand and his team have clear focus from which they will not waver in most difficult times. It has quality management of quality companies and they have stuck to it. Despite the companies delivering great returns, they believe the earnings or manager’s quality is enough. So, there’s huge amount of quality focus on that. The other thing the manager does is he also takes contrarian bets within his space. It’s interesting coming from Templeton space given the level of research they do. They don’t mind holding on to some of these ideas. (It) Might have short term pain but for the long term, Anand has done a great job delivering on the ideas. We have also seen that if the contra ideas haven’t worked and his thesis has gone wrong, he’s not afraid to cut exposure. That is a sign of a very good, clear thought process.

Why do you like Mirae Asset India Equity Fund?

Kaustubh Belapurkar: Again slightly different strategy. Franklin India is concentrated. But this is more diversified portfolio. Neelesh spends a lot of time in building the margin of safety concept. It realises the true value of the company and his team get to know that. He has known the entry price that he should be paying. There are managers who as long as they’re getting growth may not care less about valuations. But Neelesh pays attention to it, that’s when he builds the margin of safety. He will bottom up, identify the best stocks that he likes, hug the benchmark in terms of sector allocation but through stock selection process and diversification of margin of safety he is delivering consistent returns throughout.

Franklin Prima has a gold-star rating in the mid-cap category. Why?

Kaustubh Belapurkar: The focus on earnings, management and that is unwavering across strategies. It’s a different fund manager, but the ethos is same. R Janakiraman who manages the strategies is the small and mid-cap specialist at Templeton and he has driven lot of strategies, including the Prima Fund. This is more important for companies which are evolving or growing because that is somewhere you get dodgy companies and management. So, you need to have greater focus over the cleanest of balance sheet looking at lower leveraged companies which is one of the things that they look at. That is some of the things which they focus on.

Before that, I will also increase team strength. This is a point where you may not have enough coverage to feed you or generate the ideas. The team is very experienced, very large to help deliver raw material to Janakiraman and populate those stock ideas in portfolio. So, you need that kind of feet on the street to help the reasonable ideas for mid-cap size.

He doesn’t want to build a concentrated portfolio. He is cognizant of the fact that there are risks involved with mid-caps and he also tends to look at more established mid-caps rather than go down the curve in terms of some newer businesses. He will build a diversified portfolio, limit top holding to 5 percent which de-risks the portfolio.

What should people keep in mind while choosing all these categories?

Kaustubh Belapurkar: The basic rule of investing remains: identify risk and time horizon. It’s crucial. Don’t be swayed by pure returns. You need to understand how these returns were delivered or you could get into the category which isn’t meant for you.

Is the direct plan wrong way to choose a fund?

Kaustubh Belapurkar: For starters, never look at one-year performance. Look at longer track records. Our rating doesn’t come on short-term performance. But it’s risk-adjusted for 3-10 years. We’re looking at consistency of returns over a longer time period. There will be a market cycle in which fund managers don’t perform well which is okay. It may look optically bad on a point-to-point performance but if you adjust to risk and volatility, it could paint a different picture. We have done studies. The rating should be a short-listing tool rather than end decision-making tool. If you have 50 funds, then how can I come to manageable proportion of five funds? And then I can do deep digging to understand the right one for me.