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When Patience Pays Off
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Interestingly, these stocks continue to remain part of Discovery Fund's portfolio. "The fund went through a year of pain as sectors close to infrastructure did well and we were invested in fast-moving consumer goods (FMCG), information technology and pharmaceuticals, as we saw value in those sectors. Once the course of the market changed, we were proved right. As in 2007, we continue to see value in these sectors," says Naren.
His consistent performance is the reason why the fund has been rated as a long-term leader in this year's Businessworld-Value Research study of the mutual funds industry with highest five-year return on systematic monthly investments. For five years, Discovery Fund — through monthly systematic investments — generated approximately 18 per cent returns, almost a 100 basis points (bps) higher than IDFC Premier Equity Fund, which came a close second in the pecking order. During the same period, the benchmark BSE Sensex recorded a return of 5.89 per cent.
Positioned as a value fund and focused mainly on the mid- and small-cap sector, last year was rough for the fund. Its returns stayed flat at 0.12 per cent. Underperformance of metals and the fund being underweight on the FMCG sector have been the reasons for its poor performance. During the first nine months, between January and September 2011, the fund lost over 17 per cent.
However, the turnaround in the market after September 2011 saw the fund make a quick recovery — it generated 13 per cent returns in the past six months, between October and March 2012. The recovery in metal stocks and its overweight position in pharma and technology stocks contributed to the quick rebound in its fortunes.
If not for the sharp fall at the beginning of the year, the fund could have been judged the best mid and small cap fund for the second consecutive year. Despite poor performance, Discovery Fund was ranked overall second in the category that recorded a return of 42.55 per cent return over a period of three years — compared to Magnum Emerging Businesses Fund's 47.73 per cent.
Here, a question pops up. Was the change in guard in February 2011 behind the fall in the fund's performance? Mrinal Singh, who took over the fund from Naren, restructured the portfolio by exiting certain large-cap stocks such as Tata Steel, government-run banks—Punjab National Bank, Allahabad Bank and Union Bank — and Bharti Airtel and entering new sectors. Singh also increased exposure to mid- and small-cap stocks in the sugar, metal, IT, pharmaceuticals and education sectors. He picked up stocks such as Natco Pharma, MindTree, Balrampur Chini, Usha Martin, Godawari Power & Ispat and Career Point.
Says Singh, "The reason we recovered quickly is because we booked profits... we were sitting on cash and our picks moved up despite the falling market." Stocks such as Oracle Financial Services Software, MindTree and Rain Commodities came to the fund's rescue, rising anywhere between 30-40 per cent in the past year. And that is also the reason why despite no inflow of money, the fund's average assets under management (AAUM) have grown by Rs 200 crore to Rs 1,778.60 crore as of March 2012 from Rs 1,582.75 crore in March 2011.
Singh tends to believe in being a greedy investor, but will wait for the right price. He says: "As a value fund, we nurture a lot of stocks that become stars of tomorrow. But it takes time for the value to evolve and thus there are years when the stock may not give bumper returns." However, to ensure that the fund pockets some gains during a sober month, he makes use of the contra or the special situation play by picking certain large-cap stocks that are languishing due to the market mood, but have huge value. This is why Discovery Fund has stocks such as Cipla, Reliance Industries (RIL) and Sterlite Industries in its portfolio. Large-cap stocks also act as a cushion during times of short liquidity.
Sitting on 10 per cent cash, Singh is waiting for the right time to pick his favourites. Unlike last year, he does not want to make the same mistake of picking up stocks at a higher price. "To our surprise, despite picking up stock cheap, the fall in the broad market pulled down mid-cap stocks further. I do not want to make the same mistake and would rather wait than repent later."
Meanwhile, Singh is attempting to reduce the number of stocks in the fund's portfolio to 35-40. "We do not want to keep stocks that account for less than one per cent of the portfolio. If we think the stock adds value, then we increase its exposure above 1 per cent to 2-2.5 per cent, otherwise we exit."
Going forward, the fund manager expects stocks in the mid-cap auto ancillaries sector and mid-cap cement to drive his fund's returns, while his big thrust will be on export-driven stocks. We will only find out next year if Singh has nurtured the right stocks or whether he will be forced to write off his picks.
(This story was published in Businessworld Issue Dated 30-04-2012)