Low risk-to-reward ratio could prove useful as geopolitical issues are making the markets nervous

Consider equity mutual funds with good risk-to-reward profiles; these 12 MFs have beaten benchmarks

The markets have witnessed significant volatility in October, with broad-based selling across large, mid and small caps. Out of the 3,008 listed stocks with a market cap of over Rs.100 crore, 80.6% (or 2,425 stocks) delivered negative returns in October. Moreover, 1,999 stocks, or 66.4%, saw a price fall of more than 5%. The returns are calculated for closing values between 30 September and 25 October.

#sr_widget.onDemand p, #stock_pro.onDemand p{font-size: 14px;line-height: 1.28;} .onDemand .live_stock{left:17px;padding:1px 3px 1px 5px;font-size:12px;font-weight:600;line-height:18px;top:9px} #sr_widget.onDemand .sr_desc{margin:0 auto 0;} #sr_widget.onDemand .sr_desc{color: #024d99;margin-top:10px;} #sr_widget.onDemand .crypto .live_stock .lb-icon{8px 6px 5px 3px !important} #sr_widget.crypto.onDemand a.text{border-bottom:1px solid #ccc;padding-bottom:5px;display:block;width:100%} #sr_widget.onDemand .sr_desc .text p, #stock_pro.onDemand .sr_desc .text p{font-size:12px;font-weight:400;} Strong FPI selling, driven by the Chinese stimulus, low Chinese stock valuations, Middle East tensions, and crude oil volatility have weighed on the equity markets. Experts believe that the US election uncertainty, modest earnings growth in India amid weak demand, and high domestic valuations will keep volatility high in the near term. Of the 211 stocks that have declared their September quarter results so far, Reuters-Refinitiv has compiled estimates (for more than two analysts) for 132 stocks. Among these, 69 stocks, or 52.2%, missed the estimates. The Nifty 50 index trades at a TTM PE of 22.7 times, which is 0.5% higher than the past one-year average. On the other hand, the Nifty Midcap 100 and Nifty Small Cap 100 indices trade at TTM PEs of 40.3 times and 34.3 times, respectively. Compared to the past one-year average, the valuation premium of the mid- and small-cap benchmarks stood at 19.4% and 18.9%, respectively. The data is sourced from Trendlyne.

The recent volatility has also dented the performance of equity diversified mutual funds, with all 188 funds delivering negative returns in the past month. However, the resilience of equity funds is visible as 150 out of the 188 funds have lost less than their respective benchmark indices in the past month, according to data compiled from the ACE MF database. The data is based on 25 October NAVs. Equity diversified funds are best placed to manage volatility as diversification helps reduce unsystematic (companyspecific or internal) risks. However, in the current market conditions, where both the systematic (market) risks and unsystematic risks are gaining momentum, it is best to identify funds that have scored better in risk-reward profile. The risk-to-reward ratio can be determined by looking at the risk that an asset is displaying for every unit of return that it is generating. Statistically, the coefficient of variation (CV) is a good metric for understanding an asset’s risk-to-reward ratio. The CV of an asset is the ratio of its standard deviation and average return.

12 equity funds that have beaten benchmarks im-1
The standard deviation represents the total risk (market risk plus internal risk). The average or mean return represents the reward. However, CV has limitations and isn’t suitable for evaluating assets like mutual funds with negative returns during the period. Equity funds with CVs lower than their benchmark offer a favourable risk-to-reward ratio. ET Wealth analysed over 121 equity diversified funds that are over five years old. The CVs were calculated for each fund for the past one, three and five years. The weekly rolling returns data from October 2019 to October 2024 were used for computations (latest weekly return used for calculation is for the week ending 25 October 2024). Also, the CVs for each fund’s respective benchmark were worked out for the defined time frames.

Equity funds whose CVs were lower than their respective benchmark indices’ CVs in all the considered time frames (one, three and five years) were identified. There are 15 such funds. Among these, 12 funds (see table) have consistently outperformed their benchmarks on a point-to-point basis in the past one, three and five years (based on 25 October 2024 NAVs).
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Of the 12 funds, there are four flexicap, one large-cap, two large- & mid-cap, three mid-cap, and two smallcap funds. Seven are rated five-star and five four-star by Value Research. Their combined AUM reached `3.23 lakh crore at the end of September 2024, growing 80.4% year-on-year, compared to a 59.1% growth for all equity diversified funds. Most of the shortlisted funds have done well in terms of trading costs. The average portfolio turnover ratio of the group stood at 53.7% compared to the category average (equity diversified funds) of 81.8%. As many as 10 out of 12 funds had turnover ratios lower than the category average in September. The portfolio turnover ratio reflects the percentage of portfolio holdings that were changed in a year. A higher ratio means more trading costs, which affects the expense ratios and returns.

As for the portfolio composition, HDFC Bank, Zomato, Bharti Airtel, Bharat Electronics and ICICI Bank were among the stocks held by most such selected funds in September 2024. Banking and finance, power, healthcare, FMCG and automobiles were among the favoured sectors.
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This story originally appeared on: India Times - Author:Faqs of Insurances