November 24, 2009

Funds with lower cash holdings outperform: Crisil

From PFW Bureau

 CRISIL FundServices (CRISIL) study of equity funds ranked under CRISIL~CPR (CRISIL~Composite Performance Rankings) reveals that funds with lower cash holdings have outperformed in the long run. While funds with higher cash holdings do cut losses in a falling market, they tend to miss out on a subsequent rally.

Further, equity funds with minimal cash holdings fared only marginally lower during a downturn, but were able to benefit considerably more from a subsequent rally.

According to Krishnan Sitaraman, Director, CRISIL FundServices, “Investing in defensive sectors to negotiate a down market proves to be a more effective strategy as such funds can bounce back faster during a market correction. Investors invest in equity funds primarily because they are perceived as value creators and it helps them diversify from their debt investments. By taking cash calls, funds defeat this very basic objective of investors.”

CRISIL’s study on mutual fund performance over different market cycles focused on two categories of funds, one that invested more in cash during a bear phase vis-à-vis funds that continued to be fully invested in equities. In all, 115 equity funds ranked under CRISIL~CPR across large cap-oriented, diversified and, small and mid cap categories were considered.

The number of funds classified as ‘Fully invested in equities’ added up to 41 whereas the corresponding number for funds that took ‘Cash calls’ was 74. The performance trends shown by these funds were studied for the period from January 1, 2008 to July 31, 2009. The bear phase was considered from January 2008 to February 2009 and the sharp correction subsequently from March to July 2009 was considered as the bull phase.

The outcome of the analysis shows that in a downturn, taking cash calls helps cut losses, but because of the cash positions, these funds lose out from a subsequent rally when being fully invested can pay rich dividends. Also, the most notable performance in the downturn came from those fully invested funds that made timely and prudent investment calls in defensive sectors such as pharmaceuticals and fast moving consumer goods (FMCG).

To conclude, investors should be careful while considering equity funds that take active cash calls in a downturn as these funds may not benefit very significantly from a subsequent rally. On the other hand, equity funds that are fully invested with judicious levels in defensive sectors are expected to outperform over the long run, thereby adding more value to the investor’s portfolio, Crisil said in a statement.