A Handful stocks that all funds have
MAS Team | 27 February 2014
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There are over 5,000 companies listed on the Bombay Stock Exchange and nearly 3,000 stocks are listed on the National Stock Exchange. Yet, actively managed equity schemes in India have handpicked just 273 stocks for their top 10 holdings. A majority of these make up the S&P CNX 500 stocks. All but six of the 30 most picked stocks are present in the Nifty.

Most actively managed schemes, in reality, are like closet index funds. Closet index schemes are mutual fund schemes that are supposed to be actively managed in theory, but, instead, look similar to their benchmark indices. Closet index schemes exist because their managers believe that it is generally safer to have their portfolios include stocks that are present in the indices than to take on the higher risks associated with more active management.
The performance of a scheme is judged by comparing its returns to the returns of the benchmark. It is no surprise that the schemes are heavily weighted in the stocks that are present in their benchmark index. And, therefore, they tend not to deviate much from the Sensex stocks to keep the returns in line with those of the benchmark. Though the Sensex consists of 30 stocks, nearly 70% of the weightage is skewed towards the top 10 stocks. Therefore, if mutual fund schemes invest heavily in these stocks, as most of them do, the returns may be in line with those of the index. Have the top performing large-cap and multi-cap schemes done anything different? In fact, even their portfolios comprise many of the stocks included in the Nifty.

Should this worry you? After all, you pay 2.5% annually to a fund company for actively selecting, buying and selling stocks. If your fund manager is putting your money in Infosys, ITC, HDFC and so on, you might as well buy an index fund which charges 1.5%. However, things are not so simple.

We analysed the entire universe of mutual fund equity diversified schemes which includes small-cap and mid-cap schemes as well. An analysis of their portfolio showed that though the companies remain more or less the same over a period, their weightage is what fluctuates over time; this is what impacts the performance of the scheme. Of greater importance is the stocks they have picked. Stock-picking is a skill and comprises the knowledge of which stocks from an index should be left out—which an index fund will never do.

From the top ten best performing schemes, except for two schemes from Reliance Mutual Fund, the remaining eight schemes had more than 50% of their assets invested in index stocks. Leading the list was DSP BlackRock Top 100 Equity Fund which has the maximum weightage to the index stocks going up to as much as 78.02%.  This was followed by HDFC Top 200 and UTI Opportunities Fund with a weightage of 75.06% and 70.43%, respectively.
Of the schemes which invest in the highest number of index stocks, HDFC Top 200 invests in the maximum number of Nifty stocks; understandably, as it has the largest corpus as well. It is now invested in a total of 35 stocks. Of the 64 stocks present in the portfolio of Birla Sun Life Frontline Equity Fund, 33 stocks are present in the Nifty. DSP BlackRock Top 100 Equity and Canara Robeco Equity Diversified invest in 28 index stocks each, of their total stocks of 38 and 49, respectively.

A high portion of the top 10 holdings of these schemes are also present in the Nifty. Which are the top picks from the index? Infosys, Larsen & Toubro, HDFC Bank, ICICI Bank and State Bank of India are among the top 10 holdings of most of the top-performing schemes. These stocks are the top five favourites of other large-cap schemes as well. It is also pertinent to note that out of the 50 stocks that make up the Nifty, there are 22 stocks which find a place in the top 10 holdings of the selected schemes put together.

The top 10 Nifty stocks enjoy a weightage above 45% in the schemes of HDFC Growth, DSP BlackRock Top 100 Equity Fund, HDFC Top 200, Quantum Long-Term Equity Fund and HDFC Equity Fund. Not surprisingly, the most-picked Nifty stocks have heavy weightage in the Sensex as well. Infosys, State Bank of India, ICICI Bank, Larsen & Toubro, Reliance Industries, ONGC, HDFC Bank, TCS and Hindustan Unilever are not only the top picked Nifty stocks that command a high weightage in most of the schemes; they are among the top 10 stocks in the Sensex by weightage.

This is not the complete story. Despite picking the index stocks, what makes a big difference is the weightage and timing and a combination of these two. Also, a scheme that looks like an index can outperform an index by avoiding a non-performing heavyweight like Reliance or Infosys. That apart, what makes a scheme do better than another is the stocks they have selected for the non-index part of the portfolio.

Closet indexing is widely prevalent in the fund industry worldwide. A research by a Yale professor in January 2011 (“The Mutual Fund Industry Worldwide: Explicit and Closet Indexing, Fees, and Performance”— Martijn Cremers, Yale School of Management) found that actively managed schemes in many countries choose portfolios that track their stated benchmark index closely. The research showed that only a fifth of fund managers worldwide manage money on a truly active basis. According to data from the US equity mutual fund sector between 1990 and 2009, roughly a third of purportedly active managers were actually closet indexers. The study revealed that at least 40% of the fund’s benchmark index is mirrored in their portfolio.

Though the report mentioned that fund managers with the highest active share (whose holdings are most different from their benchmarks) tend to outperform, on average, their benchmarks net of expenses and trading costs, much of this depends on the term for which the stocks are held. Just because the scheme invests less in index stocks doesn’t make it superior. Mutual fund schemes declare their portfolio on a monthly basis, i.e., the stocks and their weightage at the end of the month. However, which stock and what quantity they buy or sell during the month, has a significant impact on performance.
 

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