[This post was first published on capitalmind.in]
HSBC has launched an NFO (New Fund Offering) for a Multi-Cap Equity Mutual Fund. The NFO is open from 1st to 15th July 2020. We took a look to see if it makes sense for investors.
Short Answer: Unlike Large Cap funds that produce similar returns and underperform low-cost ETFs, Multicap funds see significant performance dispersion. So it matters which fund you pick. Unless you have reason to believe the fund managers of this new fund bring a unique advantage to the table, you are better off with funds with a track record.
Read on for our take on how to think about Multicap and Focused funds, and which ones have outperformed.
The HSBC Focused Equity NFO pitch document in a nutshell:
From the NFO Document:
HSBC Focused Equity Fund aims to build a “Concentrated portfolio of equity & equity related instruments up to 30 companies across market capitalisation.
- It will be sector agnostic, will follow Top down sector allocation, and Bottom up stock selection
- Benchmark: S&P BSE 200 TRI
Should you invest in the NFO?
Unlike in the case of other recent NFOs like Motilal Oswal S&P500 Index Fund NFO and Mirae Asset Arbitrage Fund NFO, where what the fund will hold is well-known, there is no way to evaluate a specific actively managed fund even before they have picked their first set of stocks.
But we can look at how actively managed funds, and those with similar “Focused” investment strategies have done, compared to the benchmark, the BSE 200 TRI.
Returns from Active Multicap Equity Funds
There are 54 Actively Managed Multicap Equity Mutual Funds that have been around for at least a year. 13 of those state an explicit “Focused” Investment Strategy.
Chart compares the return from the BSE 200 (the stated benchmark for the HSBC Focused Fund) with median returns from Active Multicap Equity Mutual Funds and specifically, funds that have ‘Focused’ investment strategy of picking up to 30 stocks.
Interestingly, the only 1 existing Active Multicap fund with a 10 year annual return record (9.3%) is the Quantum Equity Fund of Funds that invests in other open-ended mutual funds. As of today, it’s top holdings are:
- Invesco India Growth Opportunities
- Kotak Standard MultiCap
- Mirae Asset Large Cap
- ICICI Pru Bluechip
- L&T Midcap
- Axis Bluechip and
- Franklin India Prima
And it has only ₹ 41 Crores under management.
Is a Focused strategy better?
“Focus” in a strategy sounds better than one that is not. But does that translate to a performance advantage?
Chart compares 5 year returns of Active Multicap that do not aim to invest in a concentrated set of stocks versus “Focused” Mutual Funds.
The best Multicap fund returned 12.7% over the last five years compared to 10.7% from the best Focused Multicap fund. That is not to say Focused Funds are inferior, especially when you compare how the median fund in both subset performed.
The takeaway so far is that an explicitly “Focused” strategy has not shown any noticeable advantage over one that is more general and diversified.
[bctt tweet=”For Equity Mutual Funds, an explicitly Focused strategy has not shown a noticeable advantage over one that is more general and diversified.” username=”capitalmind_in”]
Note that at the end of the day labels like “Focused” are more marketing material descriptors. For most equity mutual funds, including those that do not claim to have a Focused strategy, the top 30 holdings will make up more than 95% of the portfolio in terms of value.
Multicap Funds outperform but selectively
Chart shows the distribution of individual fund returns over 1, 3 and 5 years, annualised.
Even if we leave out the extremes, the performance difference between the 75th percentile multicap funds and the 25th percentile funds over 1, 3 and 5 years is 7.9%, 3.9% and 3,3 respectively. That can make the difference between beating a Liquid Fund and not. For Multicap Funds, who you pick matters.
[bctt tweet=”The performance difference between 75th percentile multicap funds and the 25th percentile funds over 1, 3 and 5 years is 7.9%, 3.9% and 3,3 respectively. For Multicap Funds, who you pick matters.” username=”capitalmind_in”]
When you look at individual fund performance, there are few funds that have outperformed or even underperformed over the longer term. Meaning most returns seem to be mean-reverting, with some exceptions.
Chart shows the exceptions to that statement. The highlighted bubbles belong to the same two funds.
Unlike for large cap funds where returns seem to cluster around a point under the benchmark, Multicap funds see a lot more dispersion in performance. This means while multicap funds can beat the benchmark, but choosing the right fund is critical, whether by luck, or by astute evaluation of the fund manager.
[bctt tweet=”Multicap funds can beat the benchmark, but choosing the right fund is critical, whether by luck, or by astute evaluation of the fund manager.” username=”capitalmind_in”]
Table shows all Multicap funds ordered by AUM, with the funds following a “Focus” Strategy highlighted in blue.
Here are the funds plotted by returns and volatility for better readability. (Shows only funds with five year history)
The shaded regions show funds that have shown “Strong” (Relative higher median returns with lower variability) and “Weak” (Relatively lower returns with higher variability). The bubble sizes represent current Assets under Management (AUM).
The “Strong” Performing Multicap Funds (in no particular order):
- Kotak Standard Multicap
- Parag Parikh Long Term Equity
- Aditya Birla Sun Life Equity
- SBI Magnum Multicap
Here’s the same chart only showing MultiCap funds with a “Focused” strategy, similar to that of the HSBC Focused Equity Fund. These fund are also part of the above chart showing all Multicap Funds.
A focused Multicap investment strategy does not necessarily mean better performance compared to other Multicap funds. Most Equity Funds allocate most of their assets to their top 25-30 stocks. So think of the term “Focused” in a fund’s name more as a marketing descriptor than a meaningfully different strategy.
That said, Multicap Funds as a category have shown meaningfully superior performance to the benchmark index. With significant dispersion in results within the category. Few funds have shown consistently superior returns as the bubble charts above show.
Unless the fund management team of a new-to-the-world fund brings a distinct advantage to the table, you are better off picking funds with a track record of at least three to five years i.e. from the ‘Strong’ section.
Other NFO Review Articles:
Mirae Asset Arbitrage Fund NFO [link]
Motilal Oswal S&P500 Index Fund [link]
At Capitalmind too, we manage a Multicap Portfolio as part of our Model Portfolios. We revamped the portfolio in late March this year. For access to all our research, model portfolios, and member community, upgrade to Capitalmind Premium today. Use Code CMPOFF10 to get 10% off regular price.