Recap FY24 – Fund category ranks on risk adjusted returns

10 Apr 2024 , 12:49 PM

WHY RISK ADJUSTED RETURNS FOR MUTUAL FUNDS?

We quite often use returns over a period of time to assess the performance of mutual funds. The argument is that over the long run, returns tend to reflect both returns and risk. However, the same cannot be said about the short term. For example, some fund categories may have done very well just because the amount of risk taken was too high. That could have downside risks in the medium term but may not have manifested in the short period of 1 year. Hence analysis of mutual fund performance over a 1 year needs to look at something beyond returns. There are risk-adjusted performance measures like Sharpe and Treynor, but these are based on data assumptions, which again make the output quite ambiguous.

A simple method is to use the actual data on returns and the range of returns to calculate the risk adjusted returns. In the sense, the average returns of the fund category is taken as the numerator and the variation is taken as the denominator. Average returns over a 1 year period is a fairly straight forward number and there is not much confusion about it. However, what do we use as variation. To keep things simple, we have used range as the proxy for variation. Unlike the standard deviation, which measures the extent of deviation from the mean, the range just looks at the highest and lowest range of returns for that category. The average returns when divided by the range gives risk-adjusted returns.

In this analysis, we shall look at the risk adjusted returns for different categories of funds and then to arrive at a comparison across fund classes.

BEST DEBT FUNDS IN FY24 ON RISK ADJUSTED RETURNS

The table below ranks debt fund categories based on risk adjusted returns for a 1-year period. As stated already, the range of the returns (gap between high and low) is taken as a proxy for variation or risk. It may not be precise, but it is simple and illustrative.

Debt Category	Average Returns	Star Returns	Laggard Returns	Return Range	Risk Adjusted Returns
Banking & PSU	6.16	7.81	-0.38	8.19	0.7521
Medium to Long Duration	5.91	8.05	-1.37	9.42	0.6274
10 year Government Bond	5.38	7.48	-1.20	8.68	0.6198
Long Duration	6.30	9.00	-1.28	10.28	0.6128
Low Duration	6.35	9.46	-0.97	10.43	0.6088
Government Bond	6.32	8.49	-1.94	10.43	0.6059
Corporate Bond	5.97	7.93	-1.97	9.90	0.6030
Floating Rate	7.04	12.45	-0.30	12.75	0.5522
Medium Duration	5.55	8.61	-1.47	10.08	0.5506
Ultra Short Duration	6.35	7.89	-4.76	12.65	0.5020
Dynamic Bond	5.69	9.65	-2.47	12.12	0.4695
Short Duration	5.63	12.39	-1.57	13.96	0.4033
Credit Risk	6.63	16.18	-2.16	18.34	0.3615
Money Market	1.66	7.92	-0.14	8.06	0.2060

Data Source: Morningstar India

In the above table, we have considered a total of 14 categories of debt funds and compared them on risk-adjusted returns. Here are some of the key takeaways.

• In terms of risk adjusted returns, the surprising leader of the pack was the Banking and PSU funds. These funds have given stable to above median returns in the year FY24 and the risk-adjusted returns have also been helped by the low volatility.
• The other funds at the top are the funds with a longer duration like the 10-year Government Bond Fund, Long Duration Funds and Medium to Long Duration Fund. These longer period funds have either shown less volatility or the returns have been good enough to justify the volatility.
• At the bottom, there are funds that have had discretion related issues in the past like the credit risk funds, dynamic bond funds, short duration funds etc. These funds have shown high variation, which has resulted in low levels of risk adjusted returns for the year. Surprisingly, laggards in each category saw negative returns in FY24.

Debt funds have not had a great year in FY24, although the flows have been positive in the second half of the year. With equity returns still being robust, it would take a very strong narrative to get investors interested in debt funds, especially at a time when inflation remains at elevated levels.

BEST EQUITY FUNDS IN FY24 ON RISK ADJUSTED RETURNS

Let us now turn to the best performing equity fund categories for FY24 in terms of risk adjusted returns. A total of 17 equity fund categories with a good mix of players have been considered for this ranking. Here again, the ranged based, risk adjusted returns have been used to rank the equity mutual fund categories. Check out the table below.

Equity Category	Average Returns	Star Returns	Laggard Returns	Return Range	Risk Adjusted Returns
Contra	49.69	53.42	46.28	7.14	6.9594
Sector – Healthcare	56.66	64.64	42.04	22.60	2.5071
Dividend Yield	46.49	57.43	32.87	24.56	1.8929
Sector – FMCG	19.46	16.05	5.61	10.44	1.8640
Equity- Infrastructure	65.15	84.35	46.06	38.29	1.7015
Multi-Cap	49.29	65.29	33.46	31.83	1.5485
Mid-Cap	54.46	71.99	30.72	41.27	1.3196
Small-Cap	51.91	77.92	33.24	44.68	1.1618
Equity – ESG	34.79	53.91	19.84	34.07	1.0211
ELSS (Tax Savings)	40.21	64.02	23.02	41.00	0.9807
Large-Cap	37.12	58.78	20.73	38.05	0.9756
Flexi Cap	41.98	66.65	21.47	45.18	0.9292
Value	49.12	82.62	27.14	55.48	0.8854
Focused Fund	38.98	68.14	23.12	45.02	0.8658
Large & Mid- Cap	43.96	68.08	16.30	51.78	0.8490
Sector – Financial Services	28.22	42.95	6.89	36.06	0.7826
Sector – Technology	27.91	61.38	19.24	42.14	0.6623

Data Source: Morningstar India

Here are some of the key takeaways from the ranking of equity fund categories for FY24 based on risk adjusted returns?

• What are the top performing equity funds in FY24 based on risk adjusted returns? In a year, which was marked by a frenetic rally in the Nifty, the best performers came from conservative fund management themes. Contra funds find themselves at the top as the value based approach has really worked this year. Also, other conservative categories like healthcare funds and dividend yields funds have done very well in the year. We are not considering FMCG returns due to the presence of just 1 fund in the FMCG category.
• The equity rankings of categories show a clear bias against too much discretion to the fund manager, unless that is backed by the ability to create alpha. Hence, multi-cap fund have done a lot better than the flexi cap funds, with the latter being more flexible in its approach. Also, the mid-cap and small cap funds have done much better on risk-adjusted return compared to the discretionary large & mid-cap funds.
• Let us not turn to the laggards in the equity funds category. Two sectors that have stayed under pressure in the year are financial services and technology. While financial services have been hit by the pressure on HDFC Bank post-merger; in the case of IT, there were signals of weak global growth as well as weak top line guidance by big names like Accenture for the year 2024.

Equity funds have been the star of FY24; both in terms of regular fund flows as well as performance. It remains to be seen if the equity funds can retail thein magic for longer, since he is generally keen on user experiences.

BEST HYBRID FUNDS IN FY24 ON RISK ADJUSTED RETURNS

Let us now turn to the best performing hybrid fund categories for FY24 in terms of risk adjusted returns. A total of 5 equity hybrid categories with a good mix of players have been considered for this ranking. Here again, the ranged based, risk adjusted returns have been used to rank the equity mutual fund categories. Check out the table below.

Hybrid Category	Average Returns	Star Returns	Laggard Returns	Return Range	Risk Adjusted Returns
Balanced Allocation	18.87	24.52	13.44	11.08	1.7031
Dynamic Asset Allocation	24.47	41.34	9.41	31.93	0.7664
Equity Savings	15.80	23.98	3.00	20.98	0.7531
Aggressive Allocation	31.09	53.64	11.17	42.47	0.7320
Conservative Allocation	11.56	18.56	1.35	17.21	0.6717

Data Source: Morningstar India

Here are some of the key takeaways for the hybrid funds from the ranking of risk adjusted returns.

• Among the various categories of hybrid funds, it is the balanced allocation funds that have the best risk adjusted returns. This is a rule based fund and seems to have done very well in a market that rewards innovation.
• At the bottom on the risk adjusted returns are the discretionary allocation funds like aggressive allocation funds and conservative allocation funds. Both have been volatile on returns, but in most cases, it also translates into more strategic and calibrated use of sugar globally.

Hybrids are a much smaller category and the focus on in risk reduction though multiple asset classes

BEST ALTERNATE ASSET FUNDS IN FY24

Her are the best hybrid fund categories in FY24. They are ranked descending on risk adjusted returns as under, with the range once again being used as a proxy for the variation in the returns of the stock to represent risk for the business.

Alternative Category	Average Returns	Star Returns	Laggard Returns	Return Range	Risk Adjusted Returns
Sector – Precious Metals	14.53	17.52	8.58	8.94	1.6253
Arbitrage Fund	7.38	8.66	1.19	7.47	0.9880
Liquid	6.11	9.13	-0.19	9.32	0.6556

Data Source: Morningstar India

Two things stand out quite sharply in the above data. We have included residual categories that already existed in some form or the other. Passive index funds and index ETFs are not included as they normally tend to have low variations and may distort the performance of this category. Like in the previous years, gold funds continue to flatter on the upside. This is not just about returns, but also the low volatility among the peer group.