1. Large caps’ rock-solid performance

These funds helped investors avoid extreme volatility during uncertain times.

Mutual fund investors have all the reasons to smile big. Most schemes, across categories, have delivered spectacular returns. The reason is the sharp rally in stock markets starting from the second half of 2020.

However, risk-averse investors, who stuck to only large-cap funds, were a little less fortunate than others. Large-cap funds–considered the safest–underperformed other categories. They rallied over 30% on average, less than flexi-cap (35%), large-mid-cap (41%), mid-cap (48%) and small-cap (67%).

The best schemes in the large-cap category, however, have beaten category average returns by a wide margin. According to the Fortune India-Morning Star India study, Axis Bluechip Fund, Canara Robeco Bluechip Equity and UTI Mastershare Unit are top three large-cap funds with 39.60%, 42.45% and 48.16%, returns, respectively, over the last one year.

Speaking about the outperformance of his fund, Shreyash Devalkar, senior fund manager, equity, Axis Mutual Fund, one of the two fund managers of the scheme, says, “The fund has selected stocks based on their ability to grow earnings on a sustainable basis from a medium-term perspective while maintaining a highly liquid and risk-managed portfolio. The expected earnings growth of the portfolio is higher than that of the benchmark Nifty 50 TRI (total returns index).”

The scheme navigated the volatile 2020 by keeping beta at the minimum possible level. Beta measures a stock’s volatility in relation to the overall market.

“The same logic helped us identify stocks that will participate effectively in the rally. In effect, the portfolio has delivered by managing volatility in both down and up cycles,” he says.

Canara Robeco Bluechip Equity, which is the second on the list, has followed a consistent strategy over the last five years. “The fund’s attempt to create alpha through (stock) selection rather than allocation helped it significantly. Consistent focus on businesses with superior earnings growth rather than sectors and markets and allocating weight accordingly helped the fund. Key alpha-generating sectors in last five years have been private sector financials, IT, healthcare, gas value chain and select pockets of consumption,” says Shridatta Bhandwaldar, equity head at Canara Robeco Mutual Fund.

UTI Mastershare Unit, the third on the list, has been managed by Swati Kulkarni since 2006. She says the scheme invests in companies with a strong competitive franchise and follows the principle of growth at a reasonable price. Besides, the scheme uses the 20% leeway (large-cap funds have to invest a minimum of 80% money in large-cap stocks, as defined by Sebi) by investing in companies that may be smaller but possess a competitive advantage for leading growth in their sectors. “We follow an internal risk management framework that avoids concentration by limiting per sector exposure to 35% and per stock exposure to 9.5%,” she says. The scheme’s overweight calls on IT, consumer discretionary, telecom, and underweight calls on energy, power utilities worked well for the fund. This is apart from bottom-up ideas in segments such as QSR (quick service restaurants), power exchanges, diagnostics, CRAMS (Contract Research & Manufacturing Services), bearings and airlines.

2. Mid-caps score big

With 48% gains, mid-cap funds have done a decent job of making investors richer.

Midcap funds have delivered 48% returns in last one year. Axis Midcap, PGIM India Midcap Opps Fund and Edelweiss Mid Cap have topped the Fortune India-Morningstar study 2021 in the category.

Axis Midcap focussed on identifying companies with visible cash flows and low debt. “As companies navigated through the Covid-19 lockdown, cash flows came under stress. Debt added to the stress. Highly leveraged companies will still be required to service debt and this is where cash flow management becomes critical,” says Shreyash Devalkar, senior fund manager, equity, Axis MF.

PGIM India Midcap Opps Fund’s USP has been its low overlap with the benchmark index. “We have done well in identifying turnaround companies; these are usually 10-15% of the fund. Besides, we don’t mind taking bold sectoral calls, as the team has demonstrated by being underweight on financials for a very long period of time,” says Aniruddha Naha, head, equity, PGIM India Mutual Fund.

For Edelweiss Mid Cap, a combination of allocation and stock selection in technology, financials and autos worked well. “We benefitted from cyclical orientation of the portfolio,” says Trideep Bhattacharya, Chief Investment Officer, Equities, Edelweiss Asset Management Ltd.

Should you invest in these schemes? Nishant Batra, co-founder of Fincademy, says look at the fund manager’s history. “PGIM India Midcap fund may pop-up on return charts, but its fund managers have continuously been changed. On the other hand, Edelweiss Midcap’s fund manager has been there since the scheme’s inception. It’s the sailor not the boat,” he says.

“On a three-year rolling return basis, Axis and Edelweiss have done much better than PGIM in the mid-cap category,” he adds.

3. Small-cap winners

After years of underperformance, small-cap funds stage a strong comeback.

Small-cap funds, with over 66% returns, have outperformed others.

The top three funds in the category are Axis Small Cap Fund, Kotak Small Cap and SBI Small Cap Fund with 60%, 75% and 50% returns, respectively, in last one year.

At a time when passive/index investing is getting traction, small-cap funds have drawn attention to their active strategies. “The large-cap space today has 100, mid-cap another 150 and small-cap about 3,000 listed companies of which about 500 are investable. India is a stock pickers’ market. At Axis, we focus on fundamentals with a quality bias, which helps us navigate the minefield of companies where investors often get trapped by short-term performance,” says Anupam Tiwari, fund manager, equity, Axis MF.

Talking about Kotak Small Cap, Pankaj Tibrewal, equity fund manager, Kotak Mahindra AMC, says sectors such as chemicals, home improvement (plywood, tiles, electrical wires and cables, etc), building material, consumer discretionary, select information technology and pharma have contributed to the fund’s performance over the last 12 months. The fund has invested in market leaders in each of these sectors.

R. Srinivasan, chief investment officer, equity, SBI MF, follows a sector-agnostic philosophy. “The sector weight is merely a derivative of stock-picking. We run a bottom-up philosophy of stock-picking.”

Should you start investing in small-cap funds after this outperformance? “Historically, these kinds of outperformances are followed by a period of consolidation or underperformance for some time before the next leg of outperformance kicks in,” says Nishant Batra, co-founder of Fincademy. Batra does not endorse lumpsum investment at this juncture. He suggests continuing with systematic investment plans provided small-caps fit into one’s asset allocation and suits one’s risk appetite.

4. Nimbleness pays for flexi-cap funds

These funds pick the best stocks across market caps and deliver big gains.

Flexi-cap funds provide the most elbow room to portfolio managers. While that may mean moderate to high risk for investors, the strategy has worked well for the top three funds in the category—Parag Parikh Flexi Cap, PGIM India Flexi Cap and UTI Flexi Cap. This year, flexi-cap funds have given an 34.23%, while multi-caps have delivered 43.3%. The category includes Flexi Cap, Multi Cap, ELSS, Focused Equity and Large & Mid Cap Funds.

For category winner, Parag Parikh Flexi Cap fund, responding to the fast-changing economy meant taking unconventional calls such as reducing exposure to private sector banks. “These banks are well-run, but in a tough environment, borrowers may face difficulty in repaying on time. We invested significantly in fee-based companies in the financial space instead. We also have investments in companies which benefit from increased reliance on internet or work from home environment,” says Rajeev Thakkar, chief investment officer & director, PPFAS Asset Management.

PGIM India Flexi Cap focussed on balance sheets. “We are not averse to debt but we like businesses with manageable debt. The companies must not have had any major corporate governance issues,” says Aniruddha Naha, head of equities at PGIM India Mutual Fund. UTI Flexi Cap, on the other hand, went for quality. “We search for quality, we use parameters like return on capital, cash flow, evidence of low to no debt, but when we do that, we do it over a full cycle rather than at any point of time in the cycle. The next step is to look for growth,” says Ajay Tyagi, head of equities at UTI Asset Management.

However, looking at one-two year returns does not give a good picture. Rajeev Thakkar says trailing returns are excessively high because of post-Covid rebound.

Follow us on Facebook, X, YouTube, Instagram and WhatsApp to never miss an update from Fortune India. To buy a copy, visit Amazon.