After recording phenomenal gains o ver the past two months, the market was subdued in November 2007, with the Sensex and the Nifty declining by 1.8% each, mostly on account of continued unfolding of the subprime crisis in the USA. The markets have remained more or less flat in the first half of December too on negative global cues and the 25-basis-point rate cut announced by the US Federal Reserve (Fed) in its recent meeting (as against an expectation of a 50-basis- point cut).
Financial markets across the globe got a surprise when the Fed officially reduced its economic growth forecast for 2008 to 1.8-2.5% from 2.5-2.75% forecast earlier. The economic growth forecast led to a further weakness in the dollar and an appreciation in the yen (the yen climbed to 108.8 per dollar, the highest since June 2005), which gave rise to some unwinding of the yen carry trades. As a result, most emerging markets (EMs) witnessed some correction. However, our markets outperformed the other EMs on this front, as the Sensex was down by only 1.8% in November compared with an average decline of 6.2% witnessed by the stock indices of the other major EMs.
Foreign institutional investor (FII) inflows turned negative in November to $1.4 billion, but considering the average 6.2% decline in the FII flows in the most other EMs, the outflow has not been sharp. In the first couple of days of December, inflows have been positive and after the participatory note ban, 63 new FIIs have been registered, which is almost 33% of the total number of FIIs registered in 2007. Market participants feel that fresh fund allocation coming in with the onset of the new calendar year should increase the inflows going forward. Our domestic institutions are also sitting on large cash piles of around Rs16,000 crore but so far they have preferred to sit on the sidelines. This could act as a cushion in case the FII inflows dry up and some outflows are also witnessed.
Back home, the performance of the economy has remained healthy though some moderation has been witnessed. Data released by Central Statistical Organisation shows that in September 2007, industrial production grew by 6.4% year on year (yoy) compared with a 10.7% growth in August. The Q2FY2008 GDP numbers were also a tad lower than expectations. Inflation, even though above expectations at 3.75%, continues to remain well within the Reserve Bank of India’s comfort zone of 5%. However, high crude oil prices keep chances of another round of oil price hike alive, thus putting upward pressure on the inflation figures.
On the corporate performance front, things continue to remain healthy. Corporate tax collections for the first seven months of this fiscal (from April to October) and corporate earnings in the first half of the year continue to remain buoyant. Besides liquidity, the other factor that has been driving the markets is the impressive performance of Indian companies. The advance tax numbers released recently indicate that the corporate performance in Q3FY2008 would also remain strong.
The political scenario in the country has once again come into question due to the elections in Gujarat and the 123 nuclear deal issue. Gujarat elections were keenly watched by market participants as the state is a stronghold of the Bharatiya Janata Party and the state elections were keenly contested by the Congress. The political parties continue to differ on the 123 nuclear deal signed with the USA earlier this year, thereby weakening the prospects of the deal going through
Among the global factors, the US subprime issue is likely to have much larger consequences for the US economy and world financial markets than envisaged earlier. Hence the US president has announced a housing bail-out plan. The US President George W Bush has announced a freeze on some adjustable-rate subprime mortgages for five years in an effort to stop a wave of foreclosures, which have almost doubled in the recent past from a year earlier. The government action to freeze interest rates should protect the downslide in housing prices. But then again, the longer the lower rates are extended, the more risk the same pose to the value of bonds. Hence, we need to see how these developments unfold going forward as the freeze on interest rate hike could open the flood gates of law suits and disrupt the basic viability of bond and mortgage markets.
The primary risk to global economy and markets remains a slowdown in the US economy. Latest US data shows moderate inflation, a healthy job market and record-high exports, indicating that the other sectors have so far remained insulated from the housing problem. Hence, it is more likely that the US economy will make a soft landing rather than go into a recession.
Though, global factors are likely to dictate terms, developments on the nuclear deal issue, Gujarat elections and the upcoming Q3FY2008 corporate results could also weigh on the domestic markets in the near term.
We have identified the best equity-oriented schemes available in the market today based on three parameters: the past performance as indicated by the one and two year returns, the Sharpe ratio and Fama (net selectivity).
The past performance is measured by the one and two year returns generated by the scheme. Sharpe indicates risk-adjusted returns, giving the returns earned in excess of the risk-free rate for each unit of the risk taken. The Sharpe ratio is also indicative of the consistency of the returns as it takes into account the volatility in the returns as measured by the standard deviation.
FAMA measures the returns generated through selectivity, ie the returns generated because of the fund manager’s ability to pick the right stocks. A higher value of net selectivity is always preferred as it reflects the stock picking ability of the fund manager.
We have selected the top 10 schemes upon ranking on each of the above 4 parameters and then calculated the mean value of each of the 4 parameters for the top 10 schemes. Thereafter, we have calculated the percentage underperformance or over performance of each scheme (relative performance) in each of the 4 parameters vis a vis their respective mean values.
For our final selection of schemes, we have generated a total score for each scheme giving 30% weightage each to the relative performance as indicated by the one and two year returns, 30% weightage to the relative performance as indicated by the Sharpe ratio and the remaining 10% to the relative performance as indicated by the FAMA of the scheme.
All the returns stated below, for less than one year are absolute and for more than one year the returns are annualised.
All the returns stated on next page, for less than one year are absolute and for more than one year, the returns are annualised.
Risk-return analysis The charts on the following pages give you a snapshot of how the mutual funds have performed on the risk-return parameters in the past. We have used the bubble analysis method to measure their performances on three parameters viz risk, return and fund size. The risk is measured by standard deviation, which measures the average deviation of the returns generated by a scheme from its mean returns. We have tried to explain the same with the help of a diagram, which is divided into four quadrants, with each quadrant containing funds of a particular risk-return profile. The size of the bubble indicates the size of the fund.
The funds in the high-risk high returns quadrant follow a very aggressive approach and deliver high absolute returns compared to its peers albeit at a higher risk.
The funds in the low-risk high returns quadrant outperform the peer group on the risk-adjusted returns basis as they deliver higher returns compared to its peers without exposing the portfolio to very high risk.
The funds in the low-risk low returns quadrant are not very aggressive and provide lower absolute returns, taking lower risks. The funds in the high-risk low returns quadrant underperform the peers on the risk adjusted returns basis as they adopt a high-risk strategy but the returns fail to compensate the risk taken by the fund.
For aggressive, conservative and tax planning funds, risk is measured in terms of two years’ volatility while returns are measured as two years’ average rolling returns as on November 30, 2007. For thematic and balanced funds, risk is measured in terms of one year’s volatility while returns are measured as one year’s average rolling returns as on November 30, 2007.
Every individual has a different investment requirement, which depends on his financial goals and risk-taking capacities. We at Sharekhan first understand the individual’s investment objectives and risk-taking capacity, and then recommend a suitable portfolio. So, we suggest that you get in touch with our Mutual Fund Advisor before investing in the best funds.
Disclaimer: Mutual fund investments are subject to market risk. Please read the offer document carefully before investing. Past performance may or may not be sustained in the future.