Weekly Musings – NFO Pick (Shriram Multi Sector Rotation Fund (SMURF))

28 Oct 2024 , 03:26 PM

WHY A MULTI-SECTOR ROTATION FUND?

The Shriram Multi Sector Rotation Fund (SMURF), will not just be an active fund, but also an active fund with an aggressive allocation strategy. Normally, active funds have themes like large caps, mid-caps, sectoral, etc. However, in this case, the very theme is sector rotation, which is about being in the right place at the right time. Here is why a sector rotation fund can add value to investors.

• While individual investors still manage to understand a little about stock selection, they do not understand much about sector rotation. A fund that focuses on sector rotation would be the ideal platform for investors to leverage the power of timing in markets.
• If you look at the performance of thematic funds / sector funds in India, the variations are huge. That is because different sectors and themes do well at different points of time. A sector rotation strategy ensures that you are in the right theme at the right time.
• It has an in-built tax-efficient mechanism to book profits and reallocate to sectors with potential. If the mutual fund does this churn, there are no capital gains payable. That is a key driver for any sector rotation fund.
• The sector rotation fund will focus only on 3-6 sectors, so it is sufficiently diversified. It will rotate the funds across trending sector so that you can avoid the typical sector traps, where you get stuck to sectors at the wrong stage of the product cycle.

One must bear in mind that in a sector rotation fund, the risk tend to get magnified. You not only take a position in risky active funds, but also bet on being in the right sector at the right time with proactive sector allocation and sectoral switches.

CATCHING RIGHT SECTORS AT THE RIGHT TIME

The big challenge in sectoral or thematic investing is about being in the right theme at the right time. The sector / thematic funds have become a lot more complex and expansive and hence a proper sector rotation approach can pay rich dividends for the smart investor. Here are some key data points to understand the gist of sector rotation.

• In India, sectoral / thematic funds have grown at a rapid pace. Between FY14 and FY25, the AUM of sector / thematic funds have grown from ₹19,000 Crore to ₹4,67,000 Crore; an expansion of nearly 25 times in the AUM. In addition, the monthly sector / thematic funds flows have grown from 16.2% of flows just two years back to 47.3% of the flows in the current fiscal year. This surely calls for a smart sector rotation strategy.
• Sector trap refers to the cost of being stuck to the wrong sector for too long. For instance, FY12 and FY15, the IT sector gave annualized CAGR returns of 39%. In contrast the returns on IT stocks between FY15 and FY18 was around -4%. Had you stuck on to IT after FY15, you would have only found yourself in a sector trap. This behaviour cycle repeated itself in the pre and post-COVID periods. An ideal sector rotation strategy would have been to be long on IT from FY19 to FY21 and then rotate and shift to FMCG between FY22 and FY24. That is the kind of shift that sector rotation captures.
• Empirical studies tell us that in each of the last 10 years it was possible to generate alpha by being in the right sector. That may not be practically possible, but the idea of sector rotation is to capture as many positive data points as possible. An ideal sector rotation strategy would been to be overweight on Realty & Power (FY24), on FMCG and capital goods (FY23), on Power and Metals (FY22), Metals, Auto, and IT (FY21), FMCG and IT (FY20), Oil & Gas and IT (FY19), and Consumer Services and Realty (FY18).

The gist of the story is that adopting a sector rotation approach can outperform the index in expansionary and contractionary periods. Being tax efficient, such sector rotation can generate higher CAGR returns than a plain vanilla buy-and-hold strategy.

HOW WILL SHRIRAM AMC IMPLEMENT SECTOR ROTATION STRATEGY?

Broadly, the sector identification and allocation would be a top-down approach while the actual stock selection will be a bottom-up approach. In both cases, the model will draw upon fundamental attributes, empirical back-testing and quantitative analysis of data. There are 3 thing to note about the back testing of this approach.

• Let us talk about back tested returns on this model for a lumpsum one-time investment in this model. The sector rotation would have enabled the sector rotation model of the fund to beat the index and create alpha in all these years. Over the last 5 years, the alpha ranges from 41.7% on the higher side to 4.8% on the downside.
• The same model can be tweaked to incorporate the features of a SIP investment (sort of monthly instalment approach). Even in such a case of using the SIP instead of lumpsum, the SIP on the sector rotation portfolio has outperformed the indices. The alpha has been in the vicinity of 16% to 20% in the last 5 financial years.
• What about drawdowns. How will this sector rotation model have performed during the post COVID drawdown. During this phase between December 2019 and March 2020, the drawdown on Nifty 50 was -38.44% and Nifty 500 was-38.30%. However, in case of the sector rotation portfolio, the drawdowns would have been less intense at just -30.97%.

In short, the sector rotation approach is extremely useful; not only in generating alpha, but also in defending the value of the portfolio from rapid drawdowns.

HOW THEMATIC FUNDS HAVE PERFORMED IN INDIA?

The Shriram Multi Sector Rotation Fund (SMURF) is a thematic fund NFO with focus on taking a strategic position in sectors that are likely to perform well. Hence, the Shriram Multi Sector Rotation Fund (SMURF) NFO is not just about an active strategy, but also an aggressive sector rotation theme being part of the active strategy. While, it is a very focused theme, we have considered the returns of sectoral / thematic funds as a whole as the benchmark. We have considered the 1-year, 3-year, and 5-year returns of active thematic funds in India and ranked them on 5-year CAGR returns. While there are 142 sectoral and thematic funds in India, we have only presented the top-20 thematic funds by 5-year CAGR returns in the table below.

Scheme Name	Return (%) 1-Year	Return (%) 3-Years	Return (%) 5-Years	Daily AUM (₹ in Crore)
Quant Infrastructure Fund	57.83	26.20	36.07	3,582.08
ICICI Prudential Commodities Fund	32.64	17.96	32.95	2,364.79
DSP Healthcare Fund	56.28	22.29	32.87	3,064.96
ICICI Pru Pharma Healthcare Diagnostics (PHD) Fund	61.89	23.70	32.33	4,909.55
ICICI Prudential Infrastructure Fund	54.11	31.85	31.79	6,431.95
ICICI Prudential Technology Fund	42.11	10.51	31.71	13,813.48
Invesco India Infrastructure Fund	59.38	28.66	31.70	1,544.67
Mirae Asset Healthcare Fund	55.09	20.41	31.43	2,727.24
Tata Digital India Fund	48.54	12.97	31.18	12,184.24
Bank of India Manufacturing & Infrastructure Fund	49.37	27.86	31.10	499.72
Bandhan Infrastructure Fund	61.40	29.72	30.93	1,739.59
SBI Healthcare Opportunities Fund	54.54	23.85	30.71	3,295.75
Nippon India Power & Infra Fund	54.21	30.81	30.63	7,194.79
Canara Robeco Infrastructure Fund	61.93	30.68	30.18	829.86
Aditya Birla Sun Life Digital India Fund	35.49	11.79	30.02	5,167.51
ICICI Prudential India Opportunities Fund	41.04	25.14	29.77	23,933.57
Franklin India Technology Fund	50.55	16.52	29.64	1,885.31
Nippon India Pharma Fund	50.11	20.10	29.52	8,534.83
DSP India T.I.G.E.R. Fund	59.48	32.17	29.51	5,211.29
Tata India Pharma & Healthcare Fund	55.92	22.52	29.39	1,181.32

Data Source: AMFI

The table above provides the performance and corpus of the 20 top active thematic funds based on 5-year CAGR returns. Active thematic funds have an AUM of  ₹3.55 Trillion with the AUM fairly evenly spread out across the various fund houses. We have ranked on 5-year CAGR returns, to give a more conclusive long term picture.

• Let us first look at the returns on the active thematic funds over a 1-year period. On a 1-year returns basis, these funds generated maximum returns of 77.38% and minimum returns of 13.23%, which is wide variation in returns. The average returns over a 1-year period was 41.70%, which is good; but can be risky with the high return divergence. That is more due to different sectors performing at different points of time.
• Let us turn to the returns on the active thematic funds over a 3-year period. On a 3-year returns basis, these funds generated maximum returns of 33.68% and minimum returns of -1.63%, which is wide variation once again. The average returns over a 3-year period was 18.82% CAGR, which is good; but glosses over the divergence in returns.
• Let us finally turn to the returns on the active thematic funds over a 5-year period. On a 5-year CAGR returns basis, these funds generated maximum returns of 36.07% and minimum returns of 6.36%, which is wide variation once again. The average returns over a 5-year period was 23.36% CAGR, which is good; but divergence is the issue once again.
• Which were the best themes on 5-year CAGR returns. If you look at the top-20, it is dominated by just 3 themes viz. Infrastructure, healthcare, and IT. Among the bottom performers on 5-year returns are funds with international themes, MNC funds and financial services funds.

Has the thematic story really helped beat the index. That is tough to say, especially with the huge divergence in returns. Even averages are not too reliable. However, it emerges that the big challenge in thematic funds is being in the right sector at the right time. That is where sector rotation plays a key role and the trick is to be in the right sector at the right time. That is the gap that Shriram Multi Sector Rotation Fund (SMURF) NFO intends to fill.

GLANCE AT THE SHRIRAM MULTI SECTOR ROTATION FUND (SMURF) NFO

Here are key details of the Shriram Multi Sector Rotation Fund (SMURF) NFO.

• The NFO opened on November 18, 2024 and closes on December 02, 2024. The NFO is being offered at ₹10 per unit. Being an open ended theme based active fund, the unit allotment date will be December 09, 2024. The sale and repurchase offered by the fund from December 13, 2024; at prices linked to the net asset value (NAV) of the fund.
• Being an active thematic fund on the sector rotation theme, the Shriram Multi Sector Rotation Fund (SMURF) is classified as Very High Risk on the SEBI Risk-O-Meter. This classification can be attributed to its predominant equity exposure (80-100%), thematic flavour, and an ambitious attempt to get sector rotation strategy correct. There is no guarantee on returns, although the intent is for the fund to beat the benchmark index.
• The investment objective of the fund is to offer an active sector rotation theme so that investors can rely on the fund managers to be positioned in the right theme at the right time. Wide variances in returns in thematic funds is all about timing. That is the gap that the Shriram Multi Sector Rotation Fund (SMURF) NFO intends to bridge by using the sector rotation approach to stock selection and realignment.
• Under SEBI regulations, there are no entry loads, but conditional exit loads would be imposed on exit. There will be an exit load of 1.00% of the redemption price, if the units are redeemed within 3 months from the date of allotment. There is no exit load after that. However, notwithstanding exit loads structure; it is advisable to hold such sector rotation funds for a minimum period of 5-7 years to get full sector rotation gains.
• The Shriram Multi Sector Rotation Fund (SMURF) will offer regular and direct plans. In terms of the options, the fund is only offering the growth option, but no IDCW option. Here IDCW refers to (income distribution cum capital withdrawal).
• Deepak Ramaraju and Gargi Bhattacharya will be the fund managers and would be assisted by their team. However, it may be noted here that, being an aggressive active funds, there is likely to be a lot of pressure on the fund managers. The performance of Shriram Multi Sector Rotation Fund (SMURF) will be benchmarked to Nifty 500 TRI.
• The minimum investment amount in the NFO will be ₹500 and multiples of ₹1 and additional purchases will be ₹500 and in multiples of ₹1. The fund also offers customized plans that are compatible with systematic investment plans (SIP), systematic withdrawal plans (SWP), and systematic transfer plan (SWP). For the purpose of income tax, the fund will be classified as an equity fund.

The Shriram Multi Sector Rotation Fund (SMURF) offers an aggressive active strategy to investors to participate in the sector rotation theme so as to position themselves in the right sector at the right time. Also, being an equity fund, it would be more tax efficient for investors in the long run.

TAX TREATMENT FOR SHRIRAM MULTI SECTOR ROTATION FUND (SMURF)

Shriram Multi Sector Rotation Fund (SMURF) will be classified as an equity fund for tax purposes. The tax provisions below are pursuant to the changes made in full Union Budget presented on July 23, 2024; and changes are effective for transactions after July 23, 2024.

• Dividends declared (if any) by the fund will be taxed at the peak rate of tax applicable. In addition, if the overall dividends exceed ₹5,000 in a year, they will be subject to tax deduction at source (TDS) at the extant TDS rates.
• Time frame for classification as long term capital gains (LTCG) will remain 1 year for the Shriram Multi Sector Rotation Fund (SMURF). STCG (held for less than 1 year) will be taxed at 20% on gains plus cess at 4%, making effective STCG rate 20.80%.
• The LTCG on the fund (1 year holding and above) will be taxed at a flat rate of 12.5%. However, threshold exemption limit has been increased from ₹1 Lakh to ₹1.25 Lakhs. In this case, the actual tax impact will be 13% after including 4% cess.
• What about losses? Short term losses can be written off against short term capital gains and long term capital gains. However, long term capital losses can only be written off against long term capital gains. Both, short term capital losses and long term losses (to the extent unabsorbed in the current fiscal year) can be carried forward for a period of 8 assessment years.

It is what you earn from the Shriram Multi Sector Rotation Fund (SMURF) in post-tax terms that matters. That is why, it is essential to understand tax implications.