Mutual Funds Theoretical Approach Of The Study

THEORETICAL APPROACH OF THE STUDY

PERFORMANCE EVALUATION:

After measuring the performance, next important step is to evaluate it against some suitable benchmark to address more important issues like how the measured return measures up to the similar investment opportunities. Performance evaluation will also enable the fund’s sponsor and the asset management committee to determine if the fund’s manager has enhanced the fund’s value beyond what could be obtained from a passive; indexed strategy.

Performance evaluation involves benchmarking and peer group analysis.

BENCHMARKING:

Indices are used for benchmarking mutual fund portfolio. The number and variety of available make selection of suitable benchmarks a daunting task. While choosing an index as benchmark for equity portfolio the first necessity is to pinpoint the capitalization of stocks in the index. Table below gives the risk and return of three stock indices, Nifty and Nifty Junior and Mid-cap 200 for the period 1993-2003.

	Nifty	Nifty Junior	Mid-cap 200
Annualized Return	7%	14%	13%
Annualized Risk	26%	31%	26%

The figures in the above table underline the importance of capitalization for volatility and return. The difference between the large cap figures, mid-cap figures and small cap figures is noticeable. Thus while selection an index as the benchmark for a scheme, it is important to ensure that the capitalization of the portfolio matches with that of the index. For example, in case of a fund, which is largely invested in large cap stocks, it would be inappropriate to select an index, which is constructed to reflect the performance of small cap segment of the market.

DON’T COMPARE APPLES WITH ORANGES:

The second important aspect in selecting the suitability of an index as a benchmark for a particular portfolio is the mix of stocks i.e., whether the index comprises of all growth stocks or value stocks. Specific indices are available to reflect the performance of growth stocks/value stocks in developed markets. If the fund’s investment style is value investing then the appropriate benchmark would be the value stock index. In India, so far we do not have such specific indices. But we do have sector specific indices. While evaluating the performance of sector funds, sector indices can be used.

IT IS OFFICIAL TO BENCHMARK MUTUAL FUND SCHEMES:

In India, all mutual funds are required to disclose the performance of the fund scheme against the benchmark indices. In case of equity oriented schemes, the mutual funds may select any of the indices available, e.g. BSE (Sensitive) index, S&P CNX Nifty, BSE 100, bse200 or S&P CNX 500, depending on the investment objective and portfolio of the scheme. In case of sector or industry specific schemes they may schemes any sectoral indices published by stock exchanges and other reputed agencies. For various types of debt-oriented schemes and balanced fund schemes SEBI in consultation with AMFI has arrived at specific indices (Crisil Composite bond fund index, Crisil MIP Blended index, Crisil balanced fund index, I-Sec Mi-BEX, I-Sec Li-BEX and I-Sec Composite index)

PEER GROUP ANALYSIS:

Peer group analysis is simply ranking the fund manager’s performance. The term “peer group” is generally applied to a group of fund managers defined by a specific asset class or investment style. Peer group analysis is an extensively used tool of performance evaluation by the mutual fund industry. Peer group analysis provides an actively managed benchmark alternative to a passive index benchmark (the market index). An actively managed benchmark reveals how managers that are applying similar active decision process are performing in the market.

Construction of the peer group is a tricky job. Generally a peer group is the collection of the fund managers that are investing in the similar segment of the market, i.e., equity fixed income or a mix of both. Peer groups can be more narrowly defined on the basis of style. Examples of style peer groups include funds making investment in large capitalization stocks, small capitalization, sector specific investing like technology stocks etc.,

In India, mutual fund schemes are usually categorized in the following group:

Ø  Equity – diversified

Ø  Equity – InfoTech

Ø  Equity – pharma

Ø  Equity – FMCG

Ø  Equity – Speciality

Ø  Equity tax planning

Ø  Debt – long

Ø  Debt – short

Ø  Liquid

Ø  Gild – long

Ø  Gilt – short

Ø  Balanced

CHANGE IN NAV – THE MOST COMMON MEASURE

Purpose:   If an investor wants to compute the Return on Investment between two dates, he can simply use the Per Unit Net Asset Value at the beginning and the end periods, and calculate the change in the value of the NAV between the two dates in absolute and percentage terms.

Formula: for NAV Change in absolute terms:

(NAV at the end of the period) – (NAV at the beginning of the period).

For NAV Change in percentage terms:

(Absolute change in NAV / NAV at the beginning)* 100

If period covered is less/more than one year: for annualized NAV change:

{ [(Absolute change in NAV / NAV at the beginning ) / months covered]* 12}* 100

Example: Thus, if a fund’s NAV was Rs.20 at the beginning of the year and Rs.22 at the end of the year, the absolute change was Rs. 2 (22-20) and percentage change was + 10% (22-20/20*100). Now, let us assume that an investor purchases a unit in an open-end fund at Rs.20, and its NAV after 16 months is Rs.22, the annualized NAV Changes is: 7.5%: ({[22-20]/20}/16}*12)*100.

Suitability: NAV Changes is most commonly used by investors to evaluate fund performance, and so is also most commonly published by the mutual fund managers. The advantage of this measure is that it is easily understood and applies to virtually any type of fund.

Interpretation:  Whether the return in terms of NAV Growth is sufficient or not should be interpreted in light of the investment objective of the fund, current market conditions and alternative investment returns. Thus, a long-term growth fund or infrastructure fund will give low returns in the initial years. All equity funds may give lower returns when the markets are in a bearish phase. Debt funds may give lower returns when interest rates are rising.

 Limitations: However, this measure does not always give the correct picture, in cases where the fund has distributed to investors a significant amount of dividend in the interim period. If, in the above example, 10% gives an incomplete picture. Therefore, it is suitable for evaluating growth funds and accumulation plans of debt and equity funds, but should be avoided for income funds and funds with withdrawal plans. For this reason, this measure is not considered as comprehensive as measures described below.

TOTAL RETURN

Purpose: This measure corrects the shortcoming of the NAV Change measure, by taking account of the dividends distributed by the fund between the between the two NAV dates, and adding them to the NAV change to arrive at the total return.

Formula for Total Return is:

[(Distributions + Change in NAV) / NAV at beginning of the period]* 100

Example: Let us assume that an investor purchased 1 unit of an open-end equity fund at Rs.20. The fund had an interim dividend distribution of Rs.4 per unit. Now let us assume that the NAV of the fund at year-end was Rs.22. Thus, Total Return at the end of the year for the investor was 30% [{4+ [22-20]}/20]* 100.

Suitability:  Total Return is a measure suitable for all types of funds. Performance of different types of funds can be compared on the basis of Total Return. Thus, during a given period, you can find out whether a Debt Fund gave better returns than an Equity Fund. It is also more accurate than simple NAV Change, because it takes into account distributions during the period. While using Total Return, performance must be interpreted in the light of market conditions and investment objective of the fund.

Limitations: Although more accurate than NAV Change, simple Total Return as calculated here is still inadequate as a performance measure, because it ignores the fact that distributed dividends also get reinvested if received during the year. The investor’s Total Return should take account of reinvestment of interim dividends.

Return on Investment or Total Return with Dividends Reinvested at NAV –

a)       The Most Suitable Measure

Purpose: The shortcoming of the simple Total Return is overcome by computing the Total Return with reinvestment of dividends in the fund itself at the NAV on the date of distribution (ex-dividend date). The appropriate measure of the growth of an investor’s mutual fund holdings is, therefore the Return on investment (ROI) on a cumulative basis over a certain time period. Total Return with reinvestment is such a measure of cumulative wealth accumulation, and is the same as ROI.

Formula for ROI or Total Return with Reinvestment is:

{(1 + div/ex-dividendNAV)*end NAV} – begin NAV/begin NAV*100

Example: Let us assume that an investor purchased 1 unit of an open-end equity fund at Rs.20. The fund had an interim dividend distribution of Rs. 4 per unit, when the NAV was RS. 21. The distribution of Rs.4 was reinvested in the fund at Rs. 21 per unit, giving the investor 0.19 unit (4/21) in the fund, making his total holding 1.19 (original 1 unit + 0.19 through reinvestment). Now let us assume that the NAV of the fund at year-end was Rs.22. The value of the investor’s holding at year end is RS.26.18 (22*1.19), giving the investor a Total Return with reinvestment of distributions of 30.9% ([26.18 -20]/20). Note that this is higher than the simple Total Return of 30% computed in the previous section.

Suitability: Total Return with distributions reinvested at NAV is a measure accepted by mutual fund tracking agencies such as Credence in Mumbai and Value Research in New Delhi. It is appropriate for measuring performance of accumulations plans, monthly/quarterly income schemes and debt funds that distribute interim dividend.

b)     Cumulative Aggregate vs. Average Annualized Returns

Purpose: While deploying any of the measures described above, it must be remembered that absolute NAVs do not give a complete picture ad that consistent performance with respect to Total Return and compounded annual return is of paramount importance.

In India, many mutual fund schemes, notably from Unit Trust of India, are based on cumulative returns over a long time period, e.g., Children’s Gift Growth Fund or Rajalaxmi Fund. When an investor receives a cumulative figure at end of a long period, care should be taken to compute an Annualized Average compound Rate of Return from the cumulative figure. Many mutual funds now present schemes with cumulative grow option or with dividend option. Comparison between two such schemes is possible only after the cumulative returns are turned into average annualized returns.

  Formula to convert cumulative return to average annualized return:

The maturity value of an original investment will be:

A = p*(1+r/100), given, ‘P’ = principal invested, ‘A’=maturity value of investment, ‘N’ =period of investment in years and ‘R’ = annualized compound rate in &.

The growth in maturity value can be converted to average to average annualized return as follows:

‘R’ = [(N th root of A/P) – 1)]*100.

RELIANCE BANKING FUND

Name of the Fund	Reliance Banking Fund
Nature of Scheme	(An Open-ended Banking Sector Scheme.) The primary investment objective of the Scheme is to seek to generate continuous returns by actively investing in equity / equity related or fixed income securities of banks.
Inception Date	28/05/2003
Option/Plan	Dividend Option, Growth Option and Bonus plan. The Dividend Option offers Dividend Payout and Reinvestment Facility.
Benchmark Index	S&P CNX Bank Index
Fund manager	Mr. Sunil Singhania
Entry Load (For Lump sum Purchases and investments through SIP/STP)	NIL Upfront commission shall be paid directly by the investor to the ARN Holder (AMFI registered Distributor) based on the investors' assessment of various factors including the service rendered by the ARN Holder.
Exit Load (as a % of the Applicable NAV)	NIL No Exit Load shall be levied on bonus units and units allotted on dividend reinvestment.
Minimum Application Amount	For new & existing investors: Rs.5000 and in multiples of Re. 1 thereafter.
Net Asset Value Periodicity	Every Business Day.
Redemption Proceeds	Normally dispatched within 3-4 Business days

PIE-CHART

INTERPRETATION:

In this RELIANCE BANKING FUND asset allocation in Equities are 91.81% and Debt, IDR (Indian depositor receipts), Cash and other receivables are 8.19%.

RELIANCE BANKING FUND:

YEAR	% of FUND RETURNS	% of INDEX RETURNS
2006-07	85.63	48.02
2007-08	1.02	-7.41
2008-09	26.20	21.01
2009-10	57.26	46.12
2010-11	-12.28	-7.41

TWO COLUMN CHART:

INTERPRETATION:

In reliance banking fund when compared with BSE S&P CNX BANK INDEX, reliance banking fun has gained reasonable good returns, which is mainly due to the category of securities it invested.

Even in 2007-08 the fund has performed well, even though there is collapse in the world wide security financial markets.

RELIANCE DIVERSIFIED POWER SECTOR FUND

Name of the Fund	Reliance Diversified Power Sector Fund
Nature of Scheme	The primary investment objective of the scheme is to seek to generate continuous return by actively investing in equity and equity related or fixed income securities of Power and other associated companies.
Inception Date	28/05/2003
Option/Plan	Dividend Option, Growth Option and Bonus plan. The Dividend Option offers Dividend Payout and Reinvestment Facility.
Benchmark Index	India Power Index
Fund manager	Mr. Sunil Singhania
Entry Load (For Lump sum Purchases and investments through SIP/STP)	NIL Upfront commission shall be paid directly by the investor to the ARN Holder (AMFI registered Distributor) based on the investors' assessment of various factors including the service rendered by the ARN Holder.
Exit Load (as a % of the Applicable NAV)	NIL No Exit Load shall be levied on bonus units and units allotted on dividend reinvestment.
Minimum Application Amount	For new & existing investors: Rs.5000 and in multiples of Re. 1 thereafter.
Net Asset Value Periodicity	Every Business Day.
Redemption Proceeds	Normally dispatched within 3-4 Business days

PIE-CHART:

INTERPRETATION:

In this RELIANCE DIVERSIFIED POWER SECTOR FUND asset allocation in Equities are 94.24% and Debt, Cash and other Receivables are 5.76%.

RELIANCE DIVERSIFIED POWERSECTOR FUND:

YEAR	FUND RETURNS	INDEX RETURNS
2006-07	80.38	46.86
2007-08	16.36	0.09
2008-09	21.25	15.46
2009-10	20.66	6.22
2010-11	-30.92	-34.29

TWO COLUMN CHART:

INTERPRETATION:

In the reliance diversified power sector fund when compared with benchmark of India power index the reliance diversified power sector fund has gained good returns. This mainly due to effective management of securities management by the fund manager.

RELIANCE PHARMA FUND

Name of the Fund	Reliance Pharma Fund
Nature of Scheme	The primary investment objective of the scheme is to seek to generate consistent returns by investing in equity and equity related or fixed income securities of Pharma and other associated companies.
Inception Date	8th June 2004
Option/Plan	Dividend Option, Growth Option and Bonus plan. The Dividend Option offers Dividend Payout and Reinvestment Facility.
Benchmark Index	BSE Health – Care Index
Fund manager	Mr.Sailesh RajBhan
Entry Load (For Lump sum Purchases and investments through SIP/STP)	NIL Upfront commission shall be paid directly by the investor to the ARN Holder (AMFI registered Distributor) based on the investors' assessment of various factors including the service rendered by the ARN Holder.
Exit Load (as a % of the Applicable NAV)	NIL No Exit Load shall be levied on bonus units and units allotted on dividend reinvestment.
Minimum Application Amount	For new & existing investors: Rs.5000 and in multiples of Re. 1 thereafter.
Net Asset Value Periodicity	Every Business Day.
Redemption Proceeds	Normally dispatched within 3-4 Business days

PIE-CHART:

INTERPRETATION:

In this RELIANCE PHARMA FUND asset allocation in Equities are 97.85% and Debt, Cash and other Receivables are 2.05%.

RELIANCE PHARMA FUND:

YEAR	FUND RETURNS	INDEX RETURNS
2006-07	31.58	0.97
2007-08	-2.27	-27.47
2008-09	30.90	-9.48
2009-10	62.07	36.13
2010-11	4.02	-2.13

TWO COLUMN CHART:

INTERPRETATION:

 When compared with BSE HEALTH CARE INDEX reliance pharma fund has gained reasonable good returns, which is mainly due to the category of securities it invested.

Even in 2007-08 the fund has performed well, even though there is collapse in the world wide securities financial markets.