Here are the Top 5 Equity Mutual Funds for the year 2017:
Equity mutual funds have been hot favourites among the risk-seekers. These funds invest principally in stocks of companies according to their market capitalization. The companies tend to demonstrate a high growth potential. Along with that, you might also notice a lot of share price volatility. When the price of the underlying holdings rises, it leads to maximisation of investor’s wealth. Thus, equity funds are perceived to be high-return generating havens.
But at the same time, you must not forget about the underlying risk in equity mutual funds. These funds are affected by systematic risk and unsystematic risk. Systematic risk relates to the market risk which can’t be diversified. You would receive a higher return for taking a higher systematic risk.
The unsystematic risk relates to firm-specific factors. Any change which alters the future cash flows of the firm represented by the underlying stock may increase/decrease the risk. Hence, portfolio diversification is used to eliminate unsystematic risk. Investing in more than one type of equity funds lowers the portfolio risk related to firm-specific factors.
Diversification can be fruitful only if it leads to risk reduction at a lower cost. Conversely, overlapping of holdings owing to diversification may negate the benefit of such an endeavour.
Overall, equity mutual funds have a higher standard deviation (SD) and higher beta than debt funds. Suppose the SD of an equity mutual fund is 15% and the average return is say 20%. It means that the returns could fall anywhere in the range of 5% to 35%.
Similarly, a beta of 1.5 means the fund would perform worse in a bearish market and better than the benchmark in bullish markets. Thus, both SD and beta may lead to vigorous fluctuations in the fund NAV. You need to go for these funds if you can stomach sudden losses in fund NAV.
There are primarily three kinds of equity mutual funds namely Large-caps, Mid-caps and Small-caps. The market cap of the fund affects its risk profile considerably.
Large-cap funds invest a significant proportion of its corpus in companies having large market capitalization. These happen to be well-established companies, sometimes being the market leader in their domain.
Owing to the large capital base, these tend to remain stable during market turbulence. As the risk profile is low, so the returns offered too are smaller than mid-caps & small caps. You may notice the large-cap funds giving average returns during bull runs. However, there’s small erosion in the fund value during bear runs.
In order to get the best out of large-cap funds, you need to remain invested for longer durations say more than 5 years.
Mid-cap funds invest a significant proportion of its corpus in mid-sized companies. Unlike large-caps, mid-sized companies have been on the scene for a shorter duration. These funds rank between the two extreme caps i.e. large-caps and small-caps.
These funds are riskier than large-cap funds. Hence, these funds offer higher returns but at a relatively greater risk. Mid-caps tend to outperform benchmark in the short-run, especially during bull runs. But during bear runs, these funds might give worse performance than large-caps.
Small-cap funds lie at the bottom of the equity funds pyramid. These funds invest a significant proportion of its corpus in small-sized companies. These companies are at a nascent stage of development. However, these might possess a high growth potential.
Small-cap funds have got large returns generating capability. During bull runs, these funds may beat the benchmark and give sky-high returns. People sometimes misconstrue these as get-rich-quick funds. But that’s not true.
Also read: Benchmark & its importance in mutual funds
A low capital base makes these funds highly vulnerable to various risks. Market turbulence may cause the NAV of funds to tank to unbelievable depths. Mismanagement might lead to the closure of start-ups whose stocks are held by these funds.
You won’t be able to predict the direction in which fund returns may sway. Hence, you need to be highly cautious and selective while investing in small-cap funds.
Overall, equity funds are high risk-high return bets which may turn someone from rags to riches. The reverse might also happen.
To succeed in your equity mutual funds investments, you need to be right on certain parameters.
At the very outset, fund selection becomes a crucial criterion. You need to consider both qualitative and quantitative factors. Qualitative factors pertain to fund management, fund history and fund philosophy. Quantitative factors relate to financial ratios like SD, beta, fund returns, alpha, etc.
While shortlisting the fund, you need to consider funds having a long fund history of say at least 5-10 years. It ensures that fund had experienced both the bullish and bearish phases. Then, fund returns of say 3-5 years need to be taken into account. Look for consistency in returns across time horizons. A fund which outperforms its peers and benchmark is superior to other laggard funds.
Apart from fund returns, you need to look into risk-adjusted returns as well. Sharpe and Sortino’s ratio indicates risk-adjusted return generating ability of a fund. Choose a fund with higher Sharpe & Sortino ratio.
As regards expense ratio, it forms an important parameter. Those funds having a lower expense ratio are superior to funds having higher expense ratio. A low expense ratio enables funds to deliver higher returns. Choose a fund that has the least expense ratio.
Standard deviation (SD) reflects the absolute risk of the fund. Beta indicates the relative risk of the fund in relation to the benchmark. The higher the SD and beta, higher would be the risk profile of the fund. Choose a fund whose beta and SD matches with your risk preferences.
Alpha refers to the actual returns in excess to the expected returns. It represents extra returns that can be attributed to fund manager’s contribution. The higher the alpha, the superior is the fund manager’s investment strategy.
Alpha and beta are used in conjunction to evaluate fund returns. When two funds have the same beta, fund giving higher alpha is superior to the other fund. Ideally, your fund should give higher alpha at lower beta.
Following table shows season’s top picks of large-cap, mid-cap and small-cap funds:
For relatively low-risk seekers, SBI Bluechip Fund is a suitable bet. It gives the highest risk-adjusted return at lowest beta and SD. Those who want comparable returns at lowest expense ratio may invest in Birla Sun Life Frontline Equity Fund.
SBI Magnum Midcap Fund is the most favourable investment opportunity in the above table. It gives the highest risk-adjusted return at low beta and standard deviation. Those who want the highest excess return on benchmark may go for L&T India Value Fund. It gives highest negative risk-adjusted returns at relatively low expense ratio.
DSP BlackRock Micro Cap Fund stands as the best bet in small-cap segment. It gives you the highest risk-adjusted return. Additionally, it offers you the highest excess return over & above the benchmark. Those who want to keep it less-risky may go for Franklin India Smaller Companies Fund. It has the lowest SD and beta equal to the benchmark.
Mutual Funds are subject to market risk. Please consult your Financial Advisor before investing.