EQUITY CLASSES:
Equity shares are generally classified on the basis of either the market capitalization or the anticipated movement of company earnings. it is imperative for the fund manager to understand these elements of the stocks before he selects them for inclusion in the portfolio.
a) Classification in terms of Market Capitalization
Market Capitalization is equivalent to the current value of a company, i.e., current market price per share times the number of outstanding shares. There are Large Capitalization Companies, Mid – Cap Companies and Small – Cap Companies. Different schemes of a fund may define their fund objective as a preference for the Large or Mid or the Small Cap Companies’ shares.
For example, the tax plan of ICICI Prudential AMC is essentially a mid-cap fund where as the tax plan of Reliance is large-cap fund. Large Cap shares are more liquid and hence easily tradable. Mid or Small Cap shares may be thought of as having greater growth potential. The stock markets generally have different indices available to track these different classes of shares.
b) Classification in terms of Anticipated Earnings
In terms of anticipated earnings of the companies, shares are generally classified on the basis of their market price relation to one of the following measures:
1 Price/Earning Ratio is the price of the share divided by the earnings per share and indicated what the investors are willing to pay for the company’s earning potential. Young and fast growing companies usually have high P/E ratios and the established companies in the mature industries may have lower P/E ratios.
2 Dividend Yield for a stock is the ratio of dividend paid per share to the current market price. In India, at least in the past, investors have indicated the preference for the high dividend paying shares. What matters to the fund managers is the potential dividend yields based on earning prospects.
3 Cyclical Stocks are the shares of companies whose earnings are correlated with the state of the economy.
4 Growth Stocks are shares of companies whose earnings are expected to increase at the rates that exceed the normal market levels.
5 Value Stocks are share of companies in mature industries and are expected to yield low
growth in earnings. these companies may, however, have assets whose values have not been recognized by investors in general. funds manager may try to identify such currently undervalued stocks that in their opinion can yield superior returns later.
Approaches to Portfolio Management (Fund Management Style):
Mutual funds can be broadly classified into two categories in terms of the fund management style i.e. actively managed funds and passively managed funds (popularly referred to as index funds).
Actively managed funds are the ones wherein the fund manager uses his skills and expertise to select invest-worthy stocks from across sectors and market segments. The sole intention of actively managed funds is to identify various investment opportunities in the market in order to clock superior returns, and in the process outperform the designated benchmark index. in active fund management two basic fund management styles that are prevalent are:
i) Growth Investment Style: wherein the primary objective of equity investment is to obtain capital appreciation. this investment style would make the funds manager pick and choose those shares for investment whose earnings are expected to increase at the rates that exceed the normal market levels. they tend to reinvest their earnings and generally have high P/E ratios and low Dividend Yield ratio.
ii) Value Investment Style: wherein the funds manager looks to buy shares of those companies which he believes are currently under valued in the market, but whose worth he estimates will be recognized in the market valuation eventually.
On the contrary, passively managed funds/index funds are aligned to a particular benchmark index like the S&P CNX Nifty or the BSE Sensex. The endeavor of these funds is to mirror the performance of the designated benchmark index, by investing only in the stocks of the index with the corresponding allocation or weightage.
Investing in index funds is less cumbersome as compared to investing in actively managed funds. Broadly speaking, investors need to consider two important aspects i.e. the expense ratio and the tracking error (i.e. the difference between the returns clocked by the designated index and index fund).
Conversely, investing in actively managed funds demands a deeper review and understanding of the fund house's investment philosophy; also the investor needs to decide on the kind of funds he wishes to invest in - a large cap/mid cap/small cap fund among others.
In the Indian context, the mutual fund industry is dominated by actively managed funds; index funds occupy a smaller share of the market. Well-managed actively managed funds have been successful in outperforming index funds by a huge margin.
This could be attributed to the fact that the Indian markets are still in an evolutionary phase and there exist a number of inefficiencies. These inefficiencies are in turn utilized by competent fund managers to outperform the index.
This explains why many actively managed funds manage to outperform the index over the long-term (3-5 years).
A study was conducted wherein category averages of index funds (passive funds) were compared with those of diversified equity funds (active funds), over varied time frames.
Equity shares are generally classified on the basis of either the market capitalization or the anticipated movement of company earnings. it is imperative for the fund manager to understand these elements of the stocks before he selects them for inclusion in the portfolio.
a) Classification in terms of Market Capitalization
Market Capitalization is equivalent to the current value of a company, i.e., current market price per share times the number of outstanding shares. There are Large Capitalization Companies, Mid – Cap Companies and Small – Cap Companies. Different schemes of a fund may define their fund objective as a preference for the Large or Mid or the Small Cap Companies’ shares.
For example, the tax plan of ICICI Prudential AMC is essentially a mid-cap fund where as the tax plan of Reliance is large-cap fund. Large Cap shares are more liquid and hence easily tradable. Mid or Small Cap shares may be thought of as having greater growth potential. The stock markets generally have different indices available to track these different classes of shares.
b) Classification in terms of Anticipated Earnings
In terms of anticipated earnings of the companies, shares are generally classified on the basis of their market price relation to one of the following measures:
1 Price/Earning Ratio is the price of the share divided by the earnings per share and indicated what the investors are willing to pay for the company’s earning potential. Young and fast growing companies usually have high P/E ratios and the established companies in the mature industries may have lower P/E ratios.
2 Dividend Yield for a stock is the ratio of dividend paid per share to the current market price. In India, at least in the past, investors have indicated the preference for the high dividend paying shares. What matters to the fund managers is the potential dividend yields based on earning prospects.
3 Cyclical Stocks are the shares of companies whose earnings are correlated with the state of the economy.
4 Growth Stocks are shares of companies whose earnings are expected to increase at the rates that exceed the normal market levels.
5 Value Stocks are share of companies in mature industries and are expected to yield low
growth in earnings. these companies may, however, have assets whose values have not been recognized by investors in general. funds manager may try to identify such currently undervalued stocks that in their opinion can yield superior returns later.
Approaches to Portfolio Management (Fund Management Style):
Mutual funds can be broadly classified into two categories in terms of the fund management style i.e. actively managed funds and passively managed funds (popularly referred to as index funds).
Actively managed funds are the ones wherein the fund manager uses his skills and expertise to select invest-worthy stocks from across sectors and market segments. The sole intention of actively managed funds is to identify various investment opportunities in the market in order to clock superior returns, and in the process outperform the designated benchmark index. in active fund management two basic fund management styles that are prevalent are:
i) Growth Investment Style: wherein the primary objective of equity investment is to obtain capital appreciation. this investment style would make the funds manager pick and choose those shares for investment whose earnings are expected to increase at the rates that exceed the normal market levels. they tend to reinvest their earnings and generally have high P/E ratios and low Dividend Yield ratio.
ii) Value Investment Style: wherein the funds manager looks to buy shares of those companies which he believes are currently under valued in the market, but whose worth he estimates will be recognized in the market valuation eventually.
On the contrary, passively managed funds/index funds are aligned to a particular benchmark index like the S&P CNX Nifty or the BSE Sensex. The endeavor of these funds is to mirror the performance of the designated benchmark index, by investing only in the stocks of the index with the corresponding allocation or weightage.
Investing in index funds is less cumbersome as compared to investing in actively managed funds. Broadly speaking, investors need to consider two important aspects i.e. the expense ratio and the tracking error (i.e. the difference between the returns clocked by the designated index and index fund).
Conversely, investing in actively managed funds demands a deeper review and understanding of the fund house's investment philosophy; also the investor needs to decide on the kind of funds he wishes to invest in - a large cap/mid cap/small cap fund among others.
In the Indian context, the mutual fund industry is dominated by actively managed funds; index funds occupy a smaller share of the market. Well-managed actively managed funds have been successful in outperforming index funds by a huge margin.
This could be attributed to the fact that the Indian markets are still in an evolutionary phase and there exist a number of inefficiencies. These inefficiencies are in turn utilized by competent fund managers to outperform the index.
This explains why many actively managed funds manage to outperform the index over the long-term (3-5 years).
A study was conducted wherein category averages of index funds (passive funds) were compared with those of diversified equity funds (active funds), over varied time frames.