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Fund analysis: IDFC Sterling Equity: Risks adequately rewarded
Wed, Sep 19, 2012
Source : Sanjay Kumar Singh, Citrus Interactive

IDFC Sterling Equity is a mid- and small-cap growth fund. Currently it has Rs 1,116.15 crore under management. This fund was started in February 2008 and is benchmarked against the CNX Mid-cap Index.

Fund performance

Scheme name

YTD

1-yr

3-yr

Since inception

IDFC Sterling Equity(G)

27.19

7.26

14.41

15.41

CNX Mid-cap

15.74

-3.57

5.33

--

All figures in %; as on Aug 31

The fund has done very well so far this year. Year-to-date (August 31, 2012) it is up 27.19 per cent, about 11.45 percentage points ahead of its benchmark. The fund has also beaten its benchmark over the one- and three-year horizons. Since inception it has given its investors an attractive return of 15.41 per cent compounded annually.

Scheme name

2011

2010

2009

IDFC Sterling Equity(G)*

-23.12

26.80

105.10

CNX Mid-cap*

-31.47

19.16

94.85

Out/under performance**

8.36

7.64

10.25

*Figures in %; **%age pts

Next, let us look at the fund’s calendar year wise returns to see if it has been consistent. The fund has beaten its benchmark in all the three calendar years of its existence. The margin of out-performance has also been high in each year.

The fund has also provided sound downside protection to its investors. In 2011, when the markets were declining, it declined 8.36 percentage points less than its benchmark.

The fund had its best year in 2009. It rose 105.10 per cent, almost 10.25 percentage points more than its benchmark.

Portfolio characteristics

Number of equity holdings. According to its latest portfolio disclosure, the fund holds only 15 stocks in its portfolio. This is much lower than the median stock count of 40.5 for the portfolios of all diversified-equity funds.

Historically, too, the fund has always maintained a low stock count. We have data available since June 2008. Since then the average equity count in the fund's portfolio has been 25.54.

Sector concentration. The fund's concentration in the top three, five and 10 sectors in its portfolio is much higher than the median for the diversified-equity category.

 

Top 3

Top 5

Top 10

IDFC Sterling Equity(G)

53.65

62.77

81.10

Median-diversified equity

33.43

46.42

67.44

All figures in %

Company concentration. The fund's concentration in the top three, five and 10 stocks in its portfolio is also much higher than the median for the diversified-equity category.

 

Top 3

Top 5

Top 10

IDFC Sterling Equity(G)

44.97

53.25

71.86

Median-diversified equity category

19.04

28.56

46.24

All figures in %

Based on an examination of these three characteristics—equity count, sector concentration, and company concentration—one can conclude that this is among the more concentrated funds within the diversified-equity category.

A concentrated portfolio has both pros and cons. Since the number of stocks is low, the fund manager is likely to have a better grasp of what is happening to each of his holdings. The flip side is that since each stock occupies a bigger share of the portfolio, mistakes in stock selection could have a more telling impact on performance.

Turnover ratio. According to its latest portfolio disclosure, the fund had a turnover ratio of 145 per cent. This is almost double the median of 75 per cent for the diversified-equity category. Historically too the fund has had a high turnover ratio. We have data available (in Ace MF database) since September 2009 (the fund reveals its turnover ratio only once every six months, so we have only nine data points). Over this period the fund has had an average turnover ratio of 205.44 per cent.

Our view on turnover ratio is that if the fund manager churns his portfolio more, then he must have the results to show for it, or else he only adds to trading costs. In this case, the fund manager does have the high returns to justify the high churn.

Expense ratio. This fund has an expense ratio of 2.02 per cent, which is 32 basis points lower than the median of 2.34 per cent for the diversified-equity category.

Cash calls. The fund takes active cash calls. Since June 2008 (the period of four years and one month for which we have data available) the fund has had an average cash exposure of 9.92 per cent, which is on the higher side. Its maximum cash allocation had gone as high as 27.24 per cent in April 2009.

The risk in such active cash calls is that the fund manager may not be able to switch back into equities in time to benefit from a sudden upward surge in the market.

Risk measures. Risk measures such as standard deviation and beta indicate that the fund’s level of risk is lower than the median for the diversified-equity category.

 

Standard deviation

Beta

IDFC Sterling Equity(G)

0.9500

0.6670

Median-diversified equity category

1.0084

0.8039

Risk-adjusted returns. Measures such as Treynor ratio and Sharpe ratio indicate that the fund has a much higher level of risk-adjusted return than the median for the diversified-equity category.

 

Treynor

Sharpe

IDFC Sterling Equity(G)

0.07028

0.04935

Median-diversified equity category

0.02032

0.01554

Portfolio strategy

2011. In 2011 the markets declined: the Sensex fell -24.83 per cent, the BSE Mid-cap Index fell -34.78 per cent, and the BSE Small-cap Index fell -43.63 per cent. That year the CNX Mid-cap Index fell -31.47 per cent. The fund managed to restrict its decline to -23.12 per cent.

The fund began the year with a 3.39 per cent allocation to mid-cap stocks. This rose to 37.03 per cent by September before declining to 18.02 per cent by the end of the year. The fund’s average allocation to mid-cap stocks was 19 per cent during the year.

The fund began the year with a 12.11 per cent allocation to small-cap stocks. This rose to a maximum of 18.13 per cent by August and then declined to 11.34 per cent by December. Thus the level of fluctuation in small-cap stocks was not as high as in the case of mid-cap stocks. The fund’s allocation to small-cap stocks averaged 14.80 per cent during the year.

The fund began the year with a 34.11 per cent allocation to large-cap stocks. This rose to a maximum of 37.02 per cent by October before declining to 22.34 per cent by the end of the year. The fund’s allocation to large caps averaged 31.48 per cent during the year.

The fund also had an average allocation of 22.94 per cent to 'other equities' during the year.

The fund began the year with a 5.89 per cent allocation to cash. As the markets declined, the level of cash in the portfolio rose to a high of 11.81 per cent by May before being scaled back to 4.48 per cent by December. The fund’s average allocation to cash was 5.65 per cent during the year.

In 2011 only the BSE FMCG index turned in a positive performance (9.27%). All the other sectors gave negative returns: BSE Health Care (-13.20 per cent), BSE IT (-15.62 per cent), BSE Teck (-16.52 per cent), BSE Consumer Durables (-18.13 per cent), and BSE Auto (-20.30 per cent)

Sector allocation-2011

Sector

 

Jan-11

(%)

Dec-11

(%)

Increased/reduced weight

(%age pts)

Finance - NBFC

4.18

8.22

4.04

Consumer Food

3.05

5.28

2.23

Cigarettes/Tobacco

2.29

4.13

1.84

IT - Software

3.52

4.21

0.69

Lubricants

3.58

3.61

0.03

Textile - Spinning

6.30

3.74

-2.57

During the year the fund raised its allocation to NBFCs, consumer food, cigarettes and tobacco, IT software and lubricants.

Among its top holdings, the only sector to which it reduced its exposure was textile (spinning).

Fund vs index-December 2011

Sector

Fund (%)

CNX Midcap (%)

Over/under weight

(%age pts)

Finance - NBFC

8.22

2.74

5.48

Tyres & Allied

3.19

0.93

2.26

Lubricants

3.61

1.60

2.01

TV Broadcasting & Software Production

3.47

1.95

1.52

Consumer Food

5.28

5.02

0.26

IT - Software

4.21

4.09

0.12

Cigarettes/Tobacco

4.13

--

 

Textile - Spinning

3.74

--

 

By the end of the year the fund was overweight compared to its benchmark index on NBFCs, tyres, lubricants, and so on (see table). Many of the sectors in which the fund had substantial positions are not part of the benchmark index.

2012. Year-to-date (August 31, 2012) the BSE Sensex is up 12.78 per cent, the BSE Mid-cap Index is up 16.94 per cent, and the BSE Small-cap Index is up 15.22 per cent. So far this year the fund is up 27.52 per cent, 11.91 percentage points ahead of its benchmark which is up 15.61 per cent.

So far this year the fund’s allocation to mid-cap stocks has averaged 28.57 per cent, much higher than the average for last year ( a good move since mid-caps have outperformed large-caps). Its allocation to small-cap stocks has averaged 9.72 per cent. Its allocation to large-cap stocks has averaged 35.17 per cent.

The fund also has an average allocation of 19.28 per cent to ‘other equities’ this year.

The fund began the year with a 6.33 per cent allocation to cash, but this had been brought down to 4.88 per cent by July. Overall its allocation to cash has averaged 3.69 per cent this year.

Year-to-date (August 31, 2012) the best-performing indexes are BSE FMCG (32.48 per cent), BSE Healthcare (27.29 per cent), BSE Bankex (25.36 per cent), BSE Consumer Durables (17.34 per cent), and BSE Capital Goods (16.88 per cent).

Sector allocation-2012

Sector

Jan-12

Jun-12

Raised/lowered weightage

Pharma

3.36

9.76

6.40

Finance - Housing

3.98

4.31

0.33

Lubricants

3.82

4.13

0.30

Textile - Spinning

3.77

3.99

0.22

Tyres & Allied

3.51

3.71

0.20

Consumer Food

4.90

5.09

0.19

Automobiles-Trucks/Lcv

2.56

2.66

0.10

Diesel Engines

2.73

2.83

0.10

Electric Equipment

2.99

2.85

-0.14

IT - Software

4.27

3.80

-0.47

Cigarettes/Tobacco

4.12

3.48

-0.64

Finance – NBFC

8.72

6.67

-2.05

Telecom Service  Provider

3.49

0.00

-3.49

TV Broadcasting, Software Production

2.76

0.00

-2.76

This year the fund has raised its exposure to sectors such as pharma substantially and to housing finance, lubricants, textiles, tyres, consumer food, automobiles (commercial) and diesel engines by a small magnitude (less than one percentage point).

Among its large holdings the fund has lowered its exposure considerably in TV broadcasting, telecom service providers, NBFCs, and marginally in cigarettes and tobacco, IT software and electric equipment.

Fund vs index-August 2012

Sector

Fund (%)

CNX Mid-cap (%)

Overweight/under weight
(%age pts)

Textile - Spinning

4.79

 

4.79

Finance - NBFC

7.56

2.84

4.72

Finance - Housing

3.60

 

3.60

Pharmaceuticals & Drugs

13.82

10.54

3.28

Tyres & Allied

4.15

0.93

3.22

Lubricants

4.10

1.48

2.62

IT - Software

6.57

4.04

2.53

Consumer Food

5.70

5.03

0.67

Auto Ancillary

3.79

3.86

-0.07

Among its top 10 holdings, the fund is overweight compared to its index on NBFCs, pharma, tyres, lubricants, IT software and consumer food. The fund also has considerable allocations to textile (spinning) and housing finance which are not part of the index. It is underweight compared to the index on auto ancillary.

Fund manager

This fund is managed by Kenneth Andrade who has been in charge since June 2008. Andrade is reputed to be among the best fund managers in the mid-and small-cap space. He runs another mid-and small cap fund called IDFC Premier Equity which is among the best funds in this category. Some of the other funds that he looks after include IDFC Equity, IDFC Arbitrage, IDFC Arbitrage Plus, IDFC Strategic Sector, and IDFC Infrastructure.

Conclusion

The fund carries risks that investors need to take cognizance of: a concentrated portfolio, large cash calls, and a high level of turnover. Counterbalancing these is the fact that it has given a high level of risk-adjusted return and is run by a fund manager who is among the best in the mid- and small-cap space. Weigh the pros and cons before you decide to invest.
 
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