HDFC Bank shares crash: Does it show perils of benchmark hugging by equity funds?

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While passive schemes such as exchange-traded funds (ETFs) and index funds have to adhere to the assigned weightages while constructing portfolios, active funds can alter their allocations based on fund managers’ judgement.

These weightages can then, in turn, have a proportionate impact in terms of returns.

Schemes with biggest impact

On January 17, 18, 19 and 20, shares of HDFC Bank slumped 12 percent in total, eroding nearly Rs 1.5 trillion of investors' wealth.

Returns-wise, passive sectoral funds based on the banking and financial services theme took the biggest hit on January 17 due to their large exposure to HDFC Bank. Schemes such as ICICI Prudential Nifty Bank ETF, Kotak Nifty Bank ETF, SBI Nifty Bank ETF, HDFC Nifty Bank ETF, and Axis Nifty Bank ETF slumped more than 4 percent, as per data available with ACE MF.

In terms of exposure, SBI Mutual Fund has the biggest investment in HDFC Bank, both via active and passive schemes, at Rs 62,416 crore, or 7.04 percent of the overall portfolio. To be sure, its largest scheme, the SBI Nifty ETF, is where the Employees’ Provident Fund Organisation's (EPFO) incremental corpus gets invested. This is followed by HDFC MF at Rs 24,432 crore, or 4.19 percent of the portfolio, and UTI MF at Rs 21,626 crore, or 7.64 percent.

It has been seen that many actively managed funds choose to align their scheme portfolios with the respective benchmarks. But is that a good strategy?

Perils of benchmark hugging

Actively managed schemes such as Baroda BNP Paribas Banking and Financial Services, LIC MF Banking & Financial Services, Kotak Banking & Financial Services, and HDFC Banking & Financial Services took major hits on January 17.

Even when it comes to diversified schemes, those such as Tata Large Cap, SBI Bluechip Fund, and Bandhan Large Cap Fund, with their holdings of around 10 percent in HDFC Bank, fell up to 2 percent each on the day.

According to Nirav Karkera, Head of Research at Fisdom, most actively managed mutual funds have kept a mandate that they will not be completely divergent from the benchmarks.

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“From a risk standpoint, even if funds don't see value in a stock, they don't want to completely avoid exposure to something that is heavily represented on the index,” he said.

“However, (we should) understand that many fund managers target relative performance. Managers need to generate alpha, which is outperformance over the benchmark. In such a case, it is difficult to deviate significantly from the benchmark through exclusions. However, many have historically delivered superior returns through active management. So, constituent overlap with benchmarks and deviations through weightages are also practices that have worked for many,” Karkera said.

Some funds have less exposure to HDFC Bank in their portfolios. For example, schemes such as ICICI Prudential Balanced Advantage, Kotak Flexicap, and HDFC Balanced Advantage have exposure in the range of 4-6 percent to the private sector lender.

Though rare, some mutual funds, such as Quant Mutual Fund, don’t have any allocations to HDFC Bank.

To be sure, mirroring or diverging from the benchmark doesn’t guarantee better returns, as mutual funds generate returns via stock selection and then timing the entry and exit.

Kirtan Shah, Founder of Credence Wealth Advisors, says that in the active mutual fund space, there are two types of fund managers: one, who are largely index-hugging with a little change here and there, and two, those who take very bold calls. “In the active space, you really want to be with somebody who takes active strategies, actively,” Shah said.

Can funds ignore benchmarks?

Fund managers try to align their portfolio weightages to the respective benchmarks, as a mutual fund is a relative-return product and performance is relative to the benchmark.

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“Funds cannot entirely eliminate a stock (that is, not invest anything in it), especially a stock like HDFC Bank, which has delivered consistently over the last 25 years. They have very little reason to do so. At best, they can tweak the allocation based on their preferences. HDFC and HDFC Ltd (erstwhile), have been bellwether stocks, belonging to a sector that was consistently growing and tightly tied to the India growth story. The merger between the two would have led to an increase in overall exposure,” said Deepak Chhabria, Chief Executive Officer & Director of Axiom Financial Services.

How should you react?

The answer: No.

While investing in mutual funds, reacting to the day-to-day performance of underlying stocks can be counterproductive. There are thousands of stocks on the exchanges, and they trade for around 250 days a year.

“Judging a mutual fund scheme based on a single month-end portfolio is also difficult. A scheme may hold a stock for 29 days and sell it on the last day, which would not reflect in the factsheet. So, you cannot look purely at the stock weightages and make a decision. The whole idea is that such events (the HDFC Bank stock fall) will keep happening; investors just need to stay the course and stay wiser,” said Amol Joshi, Founder, PlanRupee Investment Services.

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To achieve a diversified portfolio, it's advisable to include both active and passive funds. For successful mutual fund investments, knowledge about asset allocation and market timing is essential.

And the next time a bellwether stock falls on a given day, just stay invested. Keep monitoring, though.