Mutual Funds
IDFC League 1 Fund: What should you expect?

Another close-ended scheme investing in mid-cap stocks. What are the risks?

 
IDFC Mutual Fund plans to launch a five-year close-ended equity mutual fund scheme—IDFC League 1 Fund. The scheme would invest in equities and equity-related instruments of companies outside the top 300 companies by market-capitalisation. The scheme would invest 65%-100% in equities while the rest would be invested in debt and money market instruments. The performance of the scheme would be benchmarked to the BSE 500 index. Investing primarily in small- and mid-cap stocks, putting your money in this scheme with no exit route could be risky.
 
Recently Union KBC Mutual Fund filed its offer document to launch a unique close-ended equity scheme, Union KBC Trigger 50 Fund (Read:Union KBC Trigger 50 Fund: A Different approach, but is it worth the risk?). This was, however, just a three-year close-ended scheme. We had pointed out that three years is a short time to invest in equities as the markets can behave in a very erratic manner in a three-year time frame and worse still you could be withdrawing your investment at a loss. IDFC League 1 Fund has opted for a longer period, but still, withdrawing your investment at a predefined time can be risky. 
 
Since this is a small- and mid-cap scheme, it is important to see how similar schemes have performed in the past. Over the last quarter ended September 2012, small- and mid-cap schemes were the best performers in terms of returns (Read: Moneylife, issue dated: 1 November 2012—Best Equity Funds in the September '12 quarter). These schemes normally do well during a market rally, but you should be aware of the downside risks as well. In FY09-10, when the Sensex grew by 70%, from 10,000 to 17,000, such schemes with a similar investment objective performed really well. Birla Sunlife Small and Midcap Fund gave a return of 141% and DSP BlackRock Small and Midcap Fund followed closely with a return of 139%. However, for the calendar year 2008 when the Sensex crashed to half its value, in the same period the CNX Midcap index fell by 59%. Funds like Birla Sun Life Small and Midcap Fund and DSP BlackRock Small and Midcap Fund fell by 61% and 58%, respectively.
 
Since the performance would be benchmarked to the BSE 500, how has the index performed in five-year periods? We calculated the five-year monthly rolling returns of the BSE 500 from January 2001 to October 2012. On an average, the index has returned 21.68% compounded annualised over the 94 periods. The minimum return has been 0.94% and the maximum return has gone up to 49.88%. In 71 five-year periods out of 94, the index has delivered a return greater than 10%. A lot depends when the investment was made. Had you invested in October 2007, at the end of five years your investment would have grown by just 0.94%.
 
The minimum investment amount that would be accepted would be Rs5,000. This being a close-ended scheme, facilities like Systematic Investment Plan, Systematic Transfer Plan and Systematic Withdrawal Plan are not available to investors and no redemption or switch out of units shall be allowed prior to the maturity of the scheme. Unit holders who wish to exit may do so through the stock exchange mode. The scheme would charge up to 2.70% of the daily average net assets as fees.
 

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COMMENTS

Suiketu Shah

4 years ago

If one is a longterm investor ,best to puit in FD's and good shares like HDFC Bank,RIl,etc.Dump MF .

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Earnings in line with expectations but quality is ‘suspect’, says Kotak

Many companies reported better earnings in the September quarter not because of better operations but other income, concludes a research report by Kotak Institutional Equities. Also, many companies are facing stressful times due to poor cash flows

 

According to a research report by Kotak Institutional Equities (Kotak), the quality of earnings this season has largely been ‘suspect’ even though it beat their expectations. Most market participants obsess over profits (net profit, to be more precise). Stock prices are primarily based on this. This year, it would seem that the results met market expectations. “2QFY13 results were largely in line with our expectations with BSE-30 Index’s net profits growing 6.8% year-on-year (y-o-y),” says a Kotak report. This is 1.6% higher than expectations. This would be good news for investors, right? Not if you peer into the numbers more closely and notice that EBITDA and cash flow matter too. This is what Moneylife analyses when we write earnings results. Apart from net profit, we look at operating profit (which is EBITDA plus depreciation minus other income) for the last three successive quarters, on a year-on-year basis, to gauge performance more closely and check for consistency.
 
In its coverage of 161 stocks, 61 beat expectations—reported net profit was more than 5% of their estimates; 43 companies reported between -5% and 5%, and 57 companies reported lower than their estimates by more than 5%. Some of the sectors that surprised positively were automobiles, energy (largely due to government-owned downstream companies), pharmaceuticals and utilities. The sectors which disappointed were industrials, metals & mining and telecom. 
 
While overall net profits have indeed risen, it doesn’t mean companies’ core businesses are doing well. This is determined by EBITDA (we at Moneylife use operating profit instead in our analysis). In fact, according to the Kotak report, EBITDA declined 0.5% y-o-y which was 3.3% below their expectations. Thus net profit was actually boosted by higher “other income” component. For instance, Larsen & Toubro has reported good orders which met expectations, but largely due to an exceptional income of Rs210 crore which arose from gains on divestment of stake in a subsidiary. While this certainly adds to value of business, it isn’t exactly ‘core’ business. Likewise, one must look at every balance sheet to note the EBIDTA component and see whether it has increased y-o-y, which is how we analyse results.
 
While net profit is an important component of companies, nothing is ever more important than cash flows, which can give us clues about a company’s future performance. A strong cash flow trend will imply that the company will stay, even if net profit is subdued. After all, cash flow is result of operations and what keeps the business going while profit can go down because of higher interest, taxes or lower other income. Kotak remarked in its report, “the quality of earnings was a tad suspect with cash flows being weak in several companies”. Furthermore, it stated, “Almost all other industrial companies reported a steep increase in working capital (net working capital) quarter-on-quarter, which shows the stress on cash flows of customers”. In other words, companies are taking more time to get cash after a product is sold, or having trouble recovering from debtors. The table below illustrates this concept. 
Another aspect is the dollar-rupee exchange variable. If the rupee depreciates, IT companies (or anybody exporting) will stand to gain, and vice versa. In this quarter, several IT companies reported higher growth in rupee income but lower growth in dollar income. This shows fundamentals have not changed much other than currency rates. The table in Kotak report is shown below to illustrate this concept also.
 
 

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