John Bogle wrote a wonderful book called: Common Sense On Mutual Funds. Although Bogle is a proponent of index funds, he has given an approach using eight basic rules that should help us find the best active mutual funds.
One of the rules is to use past performance to figure consistency and risk. The essence of this rule is:
1. Over the last 12 years, the fund should be in the top two quartiles for at least six to nine years and no more than one to two years in the bottom quartile.
Using the website, valueresearchonline.com I created a spreadsheet with annual returns of large cap mutual funds from 2003 to 2015 and split them into quartiles. I excluded close-ended funds and the recently introduced direct plans. The direct plans will show a better return because of lower expense ratio. Once you choose a fund, you should always invest using the direct plan so that your returns will be better. The spread sheet and the funds that qualify can be found here. The funds have a track record of at least 12 years.
The funds that qualify are:
- Tata Pure Equity Fund – Regular Plan
- HDFC Top 200 Fund
- DSP BlackRock Top 100 Equity Fund – Regular Plan
- Franklin India Bluechip Fund
- Birla Sun Life Frontline Equity Fund
- SBI Magnum Equity Fund
- HDFC Index Fund – Sensex Plus Plan
- ICICI Prudential SPIcE Fund
- Goldman Sachs Nifty ETS Fund
- ICICI Prudential Index Fund – Regular Plan
- Once you have identified these funds you can put them into the Fund Compare Tool in the Value Research Online website.
- Here is a pdf comparing the above funds.
Then you consider the other rules that Bogle gives:
2. Select low cost funds: In India, most mutual funds have similar cost structure. The direct plans are less costly and should be chosen over the regular plans. Index funds have lower cost in India but they have not been able to beat the active funds so far. But the data we have for Indian mutual funds is not very long and it may be that over the long term, index funds will be a good choice. Even in the above list of 10 funds, there are 3 funds which are index or index-like funds.
3. Consider carefully the added cost of advice: In the Indian context, my advice would be to go for the direct plans.
4. Do not overrate past fund performance: We use the past performance to assess consistency and risk but we do not use past performance to go and blindly select the best performing funds even if they do not pass the consistency and risk tests. So you should also look at the riskiness of the funds.
5. Beware of stars: Do not invest in a fund because it is managed by a star manager. Yes, you choose the fund because it passes the other criteria but not blindly. And similarly do not worry about the number of stars the fund has, but focus on the criteria we are discussing in this post.
6. Beware of asset size: The larger a fund, the more difficult it is to get outsized returns. Hence look at whether the fund is too large and whether the returns are getting worse as the fund swells in size.
7. Do not own too many funds: Ideally after this process of screening, we should choose just one large cap fund and invest it for the large cap part of the portfolio. You can use a simple five fund formula as advised by Bogle and adapt it to your circumstances:Large cap, Mid cap, Small cap, Sector and International.
- I think for most people good options for international funds are not available and hence you can rule that out.
- Sector funds, like pharma and FMCG funds are available but they usually contain a few stocks and if you think you want to bet on a sector, you may be better off with buying individual stocks. However if you are going to use the sector funds for a small proportion of your portfolio, like say 10%, then it is okay.
- In India, we also have what we call as multicap fund. So it may be an option to have four funds: 25% large cap, 25% mid cap, 25% small cap and 25% multi cap. You can tweak the percentage to suit your risk tolerance.
8. Buy your fund portfolio and hold it: Once you decide to invest in a fund portfolio you have selected, you should buy and hold it, unless the fund fails the 1st criteria in which case you have to analyze the situation and maybe make the shift to a better fund. But funds which have had poor performance can improve and outperform and in many situations it may be the right decision to remain married as long the fund is sticking to its style and you can give it 1-2 years to see whether the performance improves.
Looking at the above funds and the pdf comparing the funds, the low and below average risk funds are:
- Franklin India Blue Chip
- Birla Sun Life Frontline Equity
- Tata Pure Equity Fund
- SBI Magnum Equity Fund
- Based on consistent performance, Birla Sun Life Frontline Equity and Tata Pure Equity have been in the top two quartiles every year over the last 12 years.
- Based on best performance, Birla Sun Life Frontline Equity is the better of the two. So one could choose Birla Sun Life Frontline equity as their large cap mutual fund.
- But any of the above four should be okay: Franklin Blue Chip has the lowest turnover ratio and is more a pure large cap while Birla Sunlife benchmarks to BSE 200.
- Another thing that can be considered is to have all four funds-multicap, small cap, mid cap and large cap from a single fund house. I like Franklin Templeton for their conservative, non-flashy approach with good long-term returns and low risk and turnover. You may like another and that is okay.
One can delve into more esoteric details but this is probably enough for most. The main thing is to choose and then invest and then sit tight.
This is just one way of systematically going about to choose a large cap mutual fund. You can use similar methods for other styles like mid cap, small cap and multi cap .
I hope this has been helpful to you.