Selection strategy: Select those equity funds that have done well in both bear and bull markets
How does one identify the best equity mutual funds? Depending on the financial planner you approach, you will get a variety of answers. Some advocate an analysis of historical returns. Determine your investment tenure, they say, and pick the top funds in the given time frame.
So, if you want to invest for three years, the adviser will suggest the funds that have given the highest returns in the past three years. Some ask for your age and investment goals, and then offer a list of funds whose investment objectives match yours closely. If you are young and ready to bear high risk, the planner will suggest sectoral, mid- or small-cap funds. Yet others talk of statistics and risk-adjusted returns, supporting funds with high alpha, beta, Treynor or Sharpe ratios.
All these methods are useful, but fund performance varies in different market conditions. So, we have figured out another way to help identify the best equity funds. We zero in on those that have done well in both bear and bull markets. A fund that does well in a bull market may be affected the most in a bear phase because even stocks with good fundamentals are hammered during a bad phase.
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There may be no noticeable reason for a reduction in stock price, but it falls due to its high sensitivity to the market. Under such conditions, the fund managers who can shift from stocks to liquid instruments or cash tend to lose less than the market. Similarly, as the market turns bullish, the fund managers who have the ability to identify undervalued quality stocks gain more than the market.
Here's how we picked the funds that did well in both the bear and bull phases. For the bear market, we analysed the returns between 8 January 2008 and 5 March 2009. The Sensex fell from 20,800 to 8,200 during this period and lost 61%; the Nifty lost 59% and equity mutual funds (on an average) lost 62%. For the bull market, we considered the returns between 6 March 2009 and 3 January 2011. The Sensex went up from 8,200 to 20,500 in this period, gaining 147%. The Nifty gained 135%, while the equity mutual funds (on an average) gained 153% in the same period. All the returns are in absolute terms.
Next, we identified the funds that had lost less than their benchmarks and category averages in the bear phase and gained more in the bull phase. We analysed all equity mutual funds, including diversified, tax plans, sectoral funds, contra and dividend yield funds. Of the 366 funds, 25 satisfied the criterion. These were the true outperformers, having done so in both the bull and bear phases.
The HDFC AMC tops with its five funds. Fidelity and Reliance AMCs shared the second spot with four funds each. The ones from Birla Sun Life, Franklin and Religare shared the third spot with two funds each. Canara, IDFC, ING, Principal, Sahara and UTI AMCs have one fund each in the list.
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