Is Your Fund Manager Investing in Overvalued Stocks?

Equity inflows into Mutual Funds are at a record-breaking level. In fact, now even some of the fund managers are getting worried about the inflows and are complaining about the sustained flows. But there is hardly any other asset class which can provide a long-term inflation-beating return. And, beware of investments in low-rated or unrated bond funds. Fear this asset class even more than an equity bubble. You are likely taking all of the risk of equity investing but without the potential upside.

In any case, let us address the question raised in the title of this OmniView: Is your Fund Manager investing overvalued stocks.

We went to the Value Research Online website for our research (Date 14–11–2017). Using the Fund Selector on the website, we selected the following:

· All Equity Funds

· Excluding:

o Plans suspended for sale

o Direct Plans

o Closed-end

No. of Funds: 382

Total Equity AUM: INR 623287 crores

We arranged the funds by their assets under management and picked the largest 10 funds. The largest was an ETF which was excluded. The next 10 funds were the funds representative of where investors are investing. These Top 10 funds represented nearly 27% of the total equity assets in mutual funds. It is likely that most sophisticated investor’s money is in one or more of these funds and that these are the ones being recommended by most distributors and advisors.

Top 10 funds AUM: INR 182482 crores

The consensus[1] is that the market is in a bubble. It has been concluded on the basis that the Nifty PE is nearly 26. So let us first look at the PE ratio of these top 10 mutual funds. Given that they are run by the most popular Fund Managers, they should have probably navigated the markets to avoid the bubbles in it. Let us see.

Nifty PE: 25.89

Average of Top10 MF Portfolio: PE 26.77

Min of Top10 MF Portfolio PE: 23.16

Max of Top10 MF Portfolio PE: 36.31

SuperNormal Portfolio PE[2]: 14.6

It is obvious that the average PE of the Top 10 funds is even higher than the markets. A few funds have a PE ratio which is marginally lower and some of them have a PE ratio as high as 36!

Looks like your Fund Manager is investing in a bubble!

It is possible that your Fund Manager has picked stocks which are of higher quality, i.e. earning high returns on equity (RoE) and hence justifies the higher PE ratios?

Nifty RoE: 13.29%

Average of Top10 MF Portfolio RoE: 11.8%

Min of Top10 MF Portfolio RoE: 8.5%

Max of Top10 MF Portfolio RoE: 16%

SuperNormal Portfolio RoE[3]: 19.9%

Again, we see that Nifty RoE is at 13.29%, while the average of the Top 10 funds is invested in lower RoE companies. In fact, except for a single fund with an RoE of 16%, all the others are invested in lower RoE companies (as a portfolio)!

So is your Fund Manager buying lower quality companies at higher prices? Is that what you signed up for?

Contrast this with the SuperNormal Portfolio. The SuperNormal Portfolio is based on the Scientific Alpha principle of buying SuperNormal Companies at SuperNormal Prices. This is not the place to discuss the intricacies of Scientific Alpha.

But, you can see that it is possible in today’s markets to buy a low PE portfolio of stocks which are not in a bubble and whose fundamental performance is much higher as signified by one such indicator, i.e. RoE.

Shouldn’t you ask your Fund Manager why he or she is not doing it?

Else, choose Scientific Alpha.

[1] The Herd is not always right; isn’t it?

[2] SuperNormal Portfolio is based on the India XLNT25 which is a model portfolio created using the Scientific Alpha multi-cap strategy of OmniScience Capital and the data is based on Oct 31 2017.

[3] SuperNormal Portfolio is based on the India XLNT25 which is a model portfolio created using the Scientific Alpha multi-cap strategy of OmniScience Capital and the data is based on Oct 31 2017.

Disclaimer:

Past performance is not necessarily indicative of future results.

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