Enter risk adjusted factor (RAF)
When we talk about the average returns of a category of funds, there could be wide variances within the category. The problem with wide variance is that it enhances risk. Fund selection becomes tough and timing of entry becomes crucial; otherwise returns may not be commensurate. Hence, we bring in the concept of Risk Adjusted Factor (RAF).
The RAF is a form of risk-adjusted return of like Sharpe and Treynor. The only difference is that instead of using Beta or standard deviation to measure volatility, we use the return range. It is a lot simpler and gives a fairly accurate picture. The RAF is nothing but the average return adjusted by the range of returns.
How various equity fund categories performed in 2020?
As we said earlier, even intuitively you can conclude that pharma funds and IT Funds would have done well. The table below captures the performance of equity fund categories.
|Equity Fund Categories||Category Average||Top Performer||Bottom Performer||Risk Adjusted Factor|
|Sector - Healthcare||66.08||82.05||54.62||2.4090|
|Sector - Technology||54.30||66.03||40.79||2.1513|
|Large & Mid- Cap||13.78||27.71||-0.56||0.4874|
|ELSS (Tax Savings)||13.30||46.71||-1.54||0.2756|
|Sector - FMCG||8.48||9.35||7.58||4.7910|
|Sector - Financial Services||-8.57||1.62||-13.82||-0.5551|
Healthcare funds and technology funds have given solid returns in 2020; both on absolute return basis and on risk-adjusted returns basis. If you consider the mid-cap funds or the small cap fund category, both have given in excess of 20% returns as a category. But, the variation in returns is also very high. Therefore, these mid cap and small cap funds don’t score too well on RAF basis.
The RAF can help you make tough choices. For example, contra fund returns are slightly lower than mid-cap funds, but even the worst performing contra fund has yielded over 12% while the worst performing mid-cap fund has only generated 2.3%. So, while mid cap fund score on returns they lose out on RAF to contra funds. You can make a choice accordingly.
How various debt fund categories performed in 2020?
Even in the case of debt funds it is intuitively possible to bet on long duration funds as yields were sharply lower. Check table below.
|Debt Fund Category||Category Average||Top Performer||Bottom Performer||Risk Adjusted Factor|
|10 yr Government Bond||10.05||13.71||-12.50||0.3834|
|Medium to Long Duration||9.39||14.21||-5.22||0.4833|
|Banking & PSU||9.34||14.52||1.61||0.7235|
|Ultra Short Duration||3.14||19.50||-38.82||0.0538|
If you leave out the long duration category, all other categories of debt funds have seen huge variation in returns. Surprisingly, even 10-year Government Bond Funds and funds of lower duration saw huge volatility in returns. If you look on a RAF basis, only Long Duration Funds and Floating Rate Funds have actually given returns and risk comfort to investors. In all the other debt fund categories, the volatility was too high.
Negative returns on credit risk funds are understandable, but how did companies earn negative returns on low duration funds and money market funds? The answer lies in the tendency to go up the risk curve in search of higher returns and also the tendency to dabble in illiquid paper. In 2020, debt funds as a category proved to be fairly risky.
Gold funds were the star category of 2020
|Other Categories||Category Average||Top Performer||Bottom Performer||Risk Adjusted Factor|
If there was a mutual funds ramp walk for 2020, gold funds would be the outright winner across all categories. A category average of over 29%, low variance in returns and a fantastic RAF means that on all counts, it was gold funds that were the real stars of 2020.