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Principal Large-cap Fund is a large-cap growth fund that was started in October 2005. Currently the fund has a corpus of Rs. 383.09 crore under management. It is benchmarked against the BSE 100 Index. At Principal, the fund manager is expected to beat the benchmark by at least 2 percentage points every year (his bonus is tied to this criterion). The upper desirable limit of outperformance is 4.5 percentage points. Beyond that, it is feared that the fund may take excessive risk which is not desirable. There is also a lot of focus on keeping volatility and tracking error within limits. The fund follows a combination of top-down and bottom-up approach. It does a fair amount of benchmarking vis-a-vis the index. This means that the fund manager cannot go above or below a certain level in a particular sector compared to the benchmark allocation. Only in exceptional cases is he allowed to exceed these limits. For instance, currently the fund has a significant overweight position in pharma (which is justifiable because pharma has good prospects and also has a very low weight in the benchmark). The fund follows a bottom-up approach for stock selection. The bottom-up selection depends heavily on Principal’s in-house proprietary research methodology, which is the same globally (see appendix for details of this approach). The fund engages in very little trading—at the most 3-4 per cent of the portfolio and that too only for existing positions (not for new stocks).
Fund performance Scheme name | YTD | 1-yr | 3-yr | 5-yr | Since inception | Principal Large Cap(G) | 18.15 | 6.49 | 7.41 | 6.07 | 15.76 | BSE-100 | 13.94 | 3.49 | 3.17 | 2.82 | -- |
All figures in %; as on August 31 Year-to-date (August 31, 2012) the fund is up 18.15 per cent whereas the BSE 100 Index is up only 13.94 per cent. Says Anupam Tiwari, the fund manager: “Some of the big bets like Divi’s, HCL Tech and Cipla had a good score in our proprietary stock ranking methodology and we went overweight on them. Those bets have paid off." The fund has also beaten its benchmark over the one-, three-, and five-year horizons. Since inception it has provided its investors a decent compounded annual return of 15.76 per cent. Scheme name | 2011 | 2010 | 2009 | 2008 | 2007 | Principal Large Cap(G)* | -26.18 | 21.03 | 105.56 | -59.51 | 72.79 | BSE-100* | -26.01 | 15.66 | 80.30 | -55.49 | 59.74 | Out/underperformance** | -0.17 | 5.37 | 25.26 | -4.02 | 13.04 |
*Figures in %; **percentage points Next, let us turn to calendar year wise performance to see if the fund has been consistent. The fund has beaten its benchmark in three of the last five calendar years. In 2011 it fell behind its benchmark by a small margin of 17 basis points (one basis point is 1/100 of a percentage point). According to the fund manager, “In 2011 we lagged behind specifically because of three or four stocks. We were slightly overweight on public sector banks and they did very poorly in the last quarter of the last calendar year. Secondly, in the early part of last year we took some infrastructure bets. Those calls went wrong. We exited those positions but after a certain amount of loss.” In 2008 the margin of underperformance was higher at 402 basis points. Says the fund manager: “In 2008 there was higher tracking error than there should have been. We were carrying higher risk than we should have in the portfolio.” The fund doesn't qualify as one that provides sound downside protection to its investors. In the last five years, both the years in which it failed to beat its benchmark were those in which the markets were declining. The fund's best performance in the last five years was in 2009 when it rose 105.56 per cent and beat its benchmark by a thumping margin of 25.26 percentage points. Portfolio characteristics Number of equity holdings. According to the fund's latest portfolio disclosure, it holds only 30 stocks. This is much lower than the median of 40.5 for the diversified-equity category. Currently the fund appears to be at its most concentrated. Historically it has held more stocks: over the last five years the number of stocks in its portfolio has averaged 40.32. The maximum it has held was 52 (in June 2011) and the minimum was 26 (in October 2007). According to the fund manager, the lowering of equity count within the portfolio is not the result of a conscious decision to move towards a more concentrated portfolio but because the market environment dictates so. He says: "A number of large-cap stocks are currently faring very poorly in our proprietary ranking methodology. Since we take this methodology very seriously, we had to reduce the number of stocks. When the overall fundamentals improve, we will move towards a higher equity count." However, he also adds that on parameters such as volatility and tracking error, they have found that the optimum level is obtained not by increasing the number of stocks but through sound selection. Sector concentration. The fund's concentration in the top three, five and 10 sectors in its portfolio exceeds the median for the diversified-equity category. | Top 3 | Top 5 | Top 10 | Principal Large Cap(G) | 40.71 | 57.96 | 75.62 | Median-diversified equity | 33.48 | 46.42 | 67.41 |
All figures in % Company concentration. Again, the fund's concentration in the top three, five and 10 stocks in its portfolio exceeds the median for the diversified-equity category. | Top 3 | Top 5 | Top 10 | Principal Large Cap(G) | 20.64 | 31.64 | 53.82 | Median-diversified equity | 19.04 | 28.56 | 46.24 |
All figures in % Based on an examination of the above three criteria—number of stocks in portfolio, sector concentration and company concentration—one can conclude that this is (currently) among the more concentrated funds within the diversified-equity category. Turnover ratio. According to the fund's latest disclosure, it has a turnover ratio of 74 per cent whereas the median for the diversified-equity category is 75 per cent. Thus, the fund manager does not indulge in excessive churning of the portfolio. Even historically the fund's turnover ratio has not been high (by industry standards). Over the last four years for which we have data available, its turnover ratio has averaged 88.86 per cent. Says the fund manager: " We don't do too much of trading. We only sell a stock when we feel that it has given us enough gains and there is not much upside left. Overall we like to have a very stable portfolio. Moreover, we do benchmarking to reduce tracking error. That too helps to reduce our turnover ratio.” Expense ratio. The fund's current expense ratio is 2.31 per cent. This is marginally lower than the median of 2.34 per cent for the diversified-equity category.Cash calls. The fund does not resort to large cash calls, which in our opinion is a positive. Its average allocation to cash over the last five years has been 4.48 per cent. Its maximum cash allocation over this period was 10.06 per cent in September 2009. Significantly, the fund's allocation to cash stayed in the single digit between September 2008 and June 2009 when the global financial crisis was at its peak. Says the fund manager: "It is our policy to maintain cash at less than 5 per cent of the portfolio. At present I have 8 per cent cash. But that is an exception. Currently the environment is such due to regulatory issues that we don't want to own certain stocks which otherwise we would have bought. In exceptional circumstances and with the permission of the CIO and the risk management head, I can go above 5 per cent. But normally we believe in having low cash." Risk measures. Risk measures such as standard deviation and beta indicate that the fund has a lower level of risk than the median for the diversified-equity category. | Standard deviation | Beta | Principal Large Cap(G) | 0.9732 | 0.7933 | Median-diversified equity | 1.0362 | 0.8112 |
Risk-adjusted returns. Measures such as Treynor ratio and Sharpe ratio indicate that the fund has a higher level of risk-adjusted return than the median for the diversified-equity category. | Treynor | Sharpe | Principal Large Cap(G) | 0.02412 | 0.01966 | Median-diversified equity | 0.02063 | 0.01473 |
Portfolio strategy 2011. In 2011 the markets declined: the Sensex fell -24.83 per cent, the BSE Mid-cap Index fell-34.78 per cent, and the BSE Small-cap Index fell -43.63 per cent. That year the BSE 100 Index fell -26.01 per cent. The fund declined -26.18 per cent, thus trailing behind its benchmark by 17 basis points. The fund began the year with a 96.20 per cent allocation to large-cap stocks. By the end of the year allocation to large caps had declined to 88.76 per cent. Overall during the year the fund's allocation to large-cap stocks averaged 93.16 per cent.During 2011 its allocation to mid-cap stocks averaged only 3.02 per cent. It had a miniscule exposure (average 0.95 per cent) to small-cap stocks between July and September. Its exposure to 'other equities' averaged 3.59 per cent during the year. The fund began 2011 with an allocation of 0.91 per cent to cash. With the markets declining, cash allocation was gradually raised to a maximum of 8.97 per cent by November. Its average allocation to cash stood at 3.59 per cent during the year. In 2011 only the BSE FMCG Index turned in a positive performance (9.27 per cent). All the other sectors gave negative returns: BSE Healthcare (-13.20 per cent), BSE IT (-15.62 per cent), BSE Teck (-16.52 per cent), BSE Consumer Durables (-18.13 per cent) and BSE Auto (-20.30 per cent). Sector allocation-2011 | Jan 2011* | Dec 2011* | Increased/reduced weight** | Bank – Public | 5.85 | 7.89 | 2.04 | Refineries | 7.14 | 8.60 | 1.46 | Bank – Private | 7.76 | 8.80 | 1.04 | Pharmaceuticals & Drugs | 9.99 | 10.87 | 0.88 | IT - Software | 14.77 | 13.80 | -0.97 | Electric Equipment | 4.57 | 3.35 | -1.21 | Power Generation/Distribution | 5.50 | 3.88 | -1.62 | Household & Personal Products | 3.94 | 2.07 | -1.86 |
*per cent; **percentage points In January 2011, the fund's top allocation was to IT software. It remained so even at the end of the year though the exposure was scaled down marginally. The fund’s next largest exposure was to pharma. Exposure to this sector was raised during the year. The fund also raised its exposure to public banks, refineries and private banks. Among its large holdings, three sectors to which exposure was lowered during the year included electric equipment, power generation and distribution, and household and personal products.
Fund vs. index-December 2011
Sector | Fund (%) | BSE 100 (%) | Over/underweight (%age points) | Bank - Private | 8.80 | 14.27 | 5.47 | Cigarettes/Tobacco | 4.38 | | 2.72 | Power Generation/Distribution | 3.88 | 3.98 | 0.10 | Refineries | 8.60 | 7.90 | -0.70 | Electric Equipment | 3.35 | 1.60 | -1.75 | Telecommunication - Service Provider | 3.84 | 2.08 | -1.76 | IT - Software | 13.80 | 11.38 | -2.42 | Bank - Public | 7.89 | 4.23 | -3.66 | Pharmaceuticals & Drugs | 10.87 | 5.12 | -5.75 |
By the end of the year, the fund was overweight compared to its index on private banks, cigarettes and tobacco, and power generation (marginally). It was underweight compared to its index on pharma, public banks, IT software, telecom service providers, electrical equipment and refineries.2012. Year-to-date (August 31, 2012) the Sensex is up to 12.46 per cent, the BSE Mid-cap Index is up 16.82 per cent and the BSE Small-cap Index is up 15.06 per cent. Year-to-date (August 31, 2012) the fund is up 18.15 per cent, much ahead of its benchmark which is up 13.94 per cent.
The fund began the year with an 88.10 per cent allocation to large-cap stocks. This had been raised to 92.80 per cent by the end of July. So far this year the fund has had an average allocation of 90.50 per cent to large-cap stocks. Its allocation to mid-cap stocks has averaged 2.93 per cent during the year. The fund’s allocation to cash has averaged 6.57 per cent this year. Year-to-date (August 31, 2012) the top-performing sector indexes this year have been BSE FMCG (32.48 per cent), BSE Healthcare (27.29 per cent), BSE Bankex (25.36 per cent), BSE Consumer Durables (17.34 per cent), BSE Capital goods (16.88 per cent) and BSE Auto (13.29 per cent). Sector allocation-July 2012 Sector | Jan-12 (%) | Jul-12 (%) | Raised/lowered allocation (%age points) | Bank – Private | 10.28 | 13.31 | 3.03 | Pharmaceuticals & Drugs | 10.22 | 13.19 | 2.97 | Refineries | 10.35 | 12.01 | 1.67 | IT - Software | 12.84 | 14.21 | 1.37 | Cigarettes/Tobacco | 4.02 | 5.24 | 1.23 | Telecommunication - Service Provider | 4.13 | 3.75 | -0.38 | Bank – Public | 8.92 | 5.09 | -3.83 |
This year the fund has raised its allocation to private banks, pharma, refineries, IT software, and cigarettes and tobacco. It has lowered its exposure to public-sector banks and telecom service providers. Sector | Fund (%) | BSE 100 (%) | Over/underweight (%age pts.) | Pharmaceuticals & Drugs | 13.19 | 5.12 | 8.07 | Refineries | 12.01 | 7.90 | 4.11 | IT - Software | 14.21 | 11.38 | 2.83 | Telecommunication - Service Provider | 3.75 | 2.08 | 1.67 | Bank – Public | 5.09 | 4.23 | 0.86 | Automobiles-Trucks/Lcv | 2.92 | 2.31 | 0.61 | Steel/Sponge Iron/Pig Iron | 2.71 | 2.60 | 0.11 | Oil Exploration | 3.18 | 3.71 | -0.53 | Bank – Private | 13.31 | 14.27 | -0.96 | Cigarettes/Tobacco | 5.24 | 7.10 | -1.86 | Finance – Housing | 2.70 | 5.60 | -2.90 |
By the end of July the fund was overweight compared to its index on pharma (by quite a heavy margin of 8.07 percentage points), refineries (again quite heavily by 4.11 percentage points), IT software (2.83 percentage points) and telecom service providers (marginally by 1.67 percentage points). It was underweight compared to its index on housing finance, cigarettes and tobacco, private banks and oil exploration. (See appendix for a detailed discussion of the fund manager’s views on the sectors that he is currently bullish and bearish on.) Fund manager
The fund is managed by Anupam Tiwari who assumed charge in August 2011. He is a chartered accountant and has worked with Reliance Mutual Fund and Reliance Life Insurance prior to joining Principal Mutual Fund. Besides this fund, he manages Principal Smart Equity Fund, a hybrid (asset allocation) fund; Principal Debt Savings MIP, a monthly income plan; and Principal Debt Savings, a conservative debt-oriented hybrid fund. Since the fund manager has been at the helm for only one year, it is too early to judge his performance. Over the one-year horizon the fund has done reasonably well, leading its benchmark by a margin of 2.99 percentage points. Bottomline This is a large-cap fund that remains true to its mandate: it has had 92.36 per cent average exposure to large-cap stocks over the last three years. Among its positives, it has low churn and does not resort to large cash calls. The fund has provided sound returns but the ride has been slightly bumpy (when viewed from a calendar year perspective). What impresses us about this fund is that the fund manager has to adhere to an elaborate in-house framework for stock picking. The emphasis on risk containment is also praiseworthy. All of this should ensure that the fund continues to give investors sound risk-adjusted returns even in future. Given its true-to-label large-cap character, the fund deserves to be a part of your core holding. Appendix
Principal’s in-house stock selection methodology
Principal’s global in-house proprietary research methodology uses 14 parameters for ranking stocks: of these 11 are fundamental and three are technical. Based on these 14 parameters the fund house creates a universe of stocks which are ranked every week (at its global headquarters in the US) from 1st to 100th percentile. The 11 fundamental parameters have a significant value bias. The fund manager has to go overweight on the top 20 percentile and he can not own any stock in the bottom quartile. In India certain stocks are big, such as Reliance. However, that stock does not rank very highly in Principal’s proprietary ranking. Principal allows the fund manager to do some pre-empting. But at the portfolio level he has to ensure that his weighted average score (based on their proprietary ranking methodology) is not more than 20 basis points lower than the benchmark's score. Fund manager Anupam Tiwari on the sectors that he is currently bullish and bearish on:
Sectors that he is bullish on Pharma. In the current uncertain environment, companies that are generating a good amount of free cash flow, and whose RoE and RoCE are high compared to the market will do better. In our in-house methodology RoE, RoCE and cash flow play a very important role. Many stocks from the pharma sector have high scores within our ranking mechanism. That is why we are overweight on this sector. The problem with the sector is that the equity base of companies in this sector is small, hence the sector’s weight in the index is small. Hence we have gone substantially overweight on this sector. Though pharma stocks look a little expensive vis-a-vis the market, given their growth prospects, their ability to generate cash flows and grow without requiring capital injection, these stocks are attractive. We're not going defensive by investing in pharma. We believe that these stocks will generate good absolute returns as the sector has reported good earnings growth. Over the next two to three years a large number of products will go off-patent in the US. This will improve the prospects of Indian pharma companies. Many of these companies get 40-60 per cent of their revenue from the US market. The depreciation of the Indian currency has also given a kicker to their earnings from abroad. Most of these companies are without debt, so they carry less risk and will give stable returns even in today's uncertain environment.IT. Valuations of IT stocks have become reasonable because of uncertainty about how the economies of US and Europe will behave. Many of these IT companies do day-to-day IT-related jobs, not high-end value-added jobs. So there is not much risk to their businesses and they should generate decent revenue growth. These companies also generate good cash flows. Moreover, this sector is not affected by the domestic policy framework around which there is lot of uncertainty today. There is also the benefit from a depreciating currency. Refineries. In case of refineries we were betting on a hike in diesel price. So we went slightly overweight on HPCL, but now we have reduced it. We made a decent amount of money on that stock.In case of Reliance, we feel that all the negativity has been priced into the stock. The valuation is quite attractive. It is still one of the lowest-cost refineries in Southeast Asia. A number of refineries are closing down in US and Europe. So Reliance's refining margins are likely to have bottomed out and should trend upward in future. It is also a very high cash flow generating company.In case of BPCL, we are slightly overweight because of its E&P story. We feel that a lot of value can be created out of the exploration blocks that it has in Mozambique and Brazil. But now our overweight position in the sector has come down because we have sold a lot of HPCL stocks. Sectors that the fund manager is bearish on Telecom. We feel that given the challenging regulatory environment, it will be difficult for Bharti to grow its earnings. We see a significant amount of downgrades coming. We were slightly slow in selling our positions in the stock. It was flagged as a bottom 20 percentile stock in our in-house ranking quite a while ago. But we were expecting some tariff hikes which could have led to some earning growth. But that didn't happen and the company’s margins came down. We don't expect any earnings upside to happen in this sector at least for the next two quarters. Hopefully by that time we will have clarity on how the spectrum auctions pan out. Then we will take a fresh look at these stocks. Banking. We will witness a period of rising NPAs (non-performing assets). Our view on the overall economy is not that positive. So we see stress within the system increasing. Given the exposure that banks have to mid-sized companies and to infrastructure companies, we feel it is not the right time to have a big exposure to these stocks. Except SBI we don't hold any public sector bank in our portfolio right now.
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