Principal large cap: Doesn't make the grade

Over the last few years, a number of NFOs (new fund offers) have been launched; many of them were either replicas of existing funds or chased pointless themes. At Personalfn, we advised investors/clients to steer clear of most of them.

It's not like we are against NFOs for the sake of it. Our view on this subject is if the NFO offers something truly unique (i.e. distinct from existing funds) and can aid the investor significantly in achieving his long-term goals, he can consider investing in the NFO.

Failing this, investors are better off investing in existing mutual funds with proven track records across time frames and market phases.

Instead of innovative schemes, NFOs came out with innovative commission structures for their agents/distributors. Not surprisingly, we saw little reason to recommend NFOs to investors/clients. When an innovative NFO (coinciding with our selection criteria and processes) did get launched, we had no hesitation in recommending it selectively to investors/clients.

Principal Large Cap Fund (PLCF) was one of the many NFOs that got our thumbs down. Sure, large cap companies are well established with a consistent track record (in areas like sales and revenues) over the long-term. Large caps offer a greater degree of stability to the investor's portfolio as compared to small/mid cap stocks.

However, the 'large cap investment proposition' was offered by just about every predominantly large cap fund at that time, PLCF certainly did not have anything unique on offer. Its own sibling, Principal Growth Fund was a predominantly large cap fund that had performed reasonably well till that stage (however, the fund's performance has lost its sheen over the years)

The investment proposition offered by the NFO

PLCF was launched in September 2005. As the name suggests, it is mandated to invest predominantly (at least 65 per cent of assets) in companies from the large cap segment. It also has the flexibility to invest upto 35 per cent of asset in small and mid cap companies and/or money market instruments.

According to its offer document, large cap companies are defined as companies having market capitalisation of greater than Rs 750 crore (i.e. Rs 7.5 billion). However the promotion/sales literature distributed by the fund house (at the time of the NFO) defined large cap companies as companies having a market capitalisation equal to or greater than Rs 3,500 crore (Rs 35 billion). Also it stated that a small part of the portfolio could be invested in stocks having a lower market capitalisation but not lower than Rs 2,000 crore (Rs 20 billion).

Our view on the NFO

Our view on PLCF at the time of the NFO was that investors should invest in existing, predominantly large cap funds with steady track records. The reasons why we were not enthused by the NFO were 1) being an NFO its performance was untested and investors were better off investing in a well established large cap fund with a proven track record and 2) the lack of clarity in its definition of large caps.

Since, PLCF has been in existence for over 2 years, we thought now would be a good time to evaluate its performance vis-à-vis peers and see if the fund has lived up to investors' expectations.

The face-off

(Source: Credence Analytics. NAV data as on April 14, 2008.)

(Standard Deviation highlights the element of risk associated with the fund. Sharpe Ratio is a measure of the returns offered by the fund vis-à-vis those offered by a risk-free instrument)

For the purpose of peer comparison, we have considered only those equity funds, which invest predominantly in companies from large cap segments.

Over the last 12 months, PLCF has appreciated by 22.4 per cent and trailed most of the funds in its peer group. It has failed to outperform its benchmark index i.e. S&P CNX Nifty (24.8 per cent) over the same tenure. Since inception, PLCF has grown by 33.6 per cent CAGR (compounded annualised growth rate).

Volatility

Standard Deviation measures the risk the fund has exposed investors to; a lower Standard Deviation means lower risk. With a Standard Deviation of 9.22 per cent, PLCF and UTI Master Plus have proved to be the most volatile funds in the peer group; DSP ML Top 100 (8.69 per cent) delivers the best performance.

Risk-adjusted return

Sharpe Ratio evaluates how well the mutual fund has compensated investors for the risk borne (the risk-free government security is considered for the purpose of evaluation). With a Sharpe Ratio of 0.11 per cent, the fund pitches in an average performance, while DSP ML Top 100 (0.14 per cent) delivers an excellent performance and tops the slot.

As can be seen in the graph, Rs 100 invested in PLCF on inception (November 2005) would have grown to approximately Rs 210 by April 14, 2008, while the same amount invested in the benchmark index i.e. S&P CNX Nifty would have been worth Rs 188.

In a nutshell . . .

PLCF's performance on the risk and returns parameters vis-à-vis its peers is disappointing. This clearly proves that not every NFO merits investor's monies. It must be mentioned here, that these are early days for the fund. Ideally, equity-oriented funds should be evaluated over a longer time frame (at least 3-5 years).

The possibility of PLCF delivering an impressive showing over the long-term cannot be ruled out. However it can be stated that in its existence so far, the fund's performance has been far from impressive.

What should investors do?

Should investors consider investing in PLCF or liquidate their existing investments? Well, that would depend on the investor's risk appetite, investment objective and existing portfolio, among a host of other factors.

At Personalfn, we have always maintained that a 'one size fits all' approach doesn't work while investing. An investment avenue that is apt for one investor could be grossly unsuitable for another. Investors would do well to consult their investment advisors/financial planners to determine the suitability of PLCF in their portfolios.

• Your family's future depends on this. Read now