Choosing mutual fund SIPs

22 Mar 2024 , 11:55 AM

RISE AND RISE OF SIPS IN THE INDIAN CONTEXT

Systematic investment plans (SIPs) have been the big drivers of mutual funds flows in the last 8 years, but it has become especially pronounced in the post-pandemic period. To an extent, that can be attributed to the fact that those who stuck to their SIPs through the COVID phase, ended up laughing all the way to the bank. That was, probably, the most eloquent lesson that if you clench your teeth and sustain SIPs through tough times, the returns can be phenomenal. The results are there for all to see.

Today, the average monthly SIP flows have nearly doubled in the post COVID period. In February 2024, the monthly SIP flows was ₹18,197 Crore at a gross level. But that is just the high frequency data. What is more relevant is that today, the SIP folios are at 8.20 Crore, which is nearly 50% of all SIP folios in India. The SIP AUM has crossed ₹10 Crore and that is nearly one-fifth of the overall AUM of Indian mutual funds. In short, SIPs have arrived as an asset class within mutual funds. Hence it is only appropriate that we understand in details how to go about choosing the best SIP in the market.

USING XIRR INSTEAD OF CAGR TO EVALUATE SIPS

Before get into the nuances of choosing the best SIPs in India, here is a quick detour. You can evaluate lumpsum investment returns based on either point-to-point returns or CAGR returns. However, SIP is a slightly different ball game as it involves regular periodic investment in a fund. Hence, the time value of each individual flow will differ. In such cases, the CAGR may not be the appropriate measure. Instead, you must use XIRR (Extended Internal rate of return) as a proxy for evaluating the performance of SIP funds. Let us first look at what exactly is this XIRR.

XIRR, or extended internal rate of return, is a financial metric that is used to calculate the annualized rate of return for investments, especially when the cash flows are irregular. XIRR gives appropriate time value weightage to each specific cash flows and hence the XIRR can be used for regular cash flows and also for irregular cash flows. That is what makes the XIRR a very useful metrics for evaluating the performance of investments like systematic investment plans (SIPs), flexible SIPs, Trigger SIPs and step-up SIPs, where the cash flows are not evenly distributed over a period of time.

Having understood what is XIRR, let us look at how XIRR differs from the traditional CAGR returns. As we all know, CAGR (Compound Annual Growth Rate), is a rather simple measure that calculates the average annual growth rate of an investment over a specified period, assuming that the investment grows at a relatively stable rate. On the other hand, the XIRR also considers the timing and magnitude of cash flows in addition to the final value of the investment. The annualized XIRR gives adequate weightage to specific contributions, timing of the contribution, timing of the redemption and quantum of redemption. In the case of SIPs, the XIRR provides a more accurate representation of investment performance. XIRR is relatively more complex compared to CAGR, but gives a much better picture of implied returns for products like SIPs, where contributions are periodic and market value fluctuates.

BEST SIP FUNDS IN INDIA ON 5 YEAR XIRR

To look at SIP performance, we look at XIRR (Extended Internal Rate of Return) returns over a 5 year period. The assumption is a monthly SIP of ₹10,000 over a 5-year period. The table below captures the top SIP based equity funds in the Indian context.

Fund Name	Total Outlay	Grew To	Wealth Ratio	TER	5-Year XIRR
Quant Active Fund	6,00,000	13,34,000	2.22X	0.71%	32.64%
Quant Large & Mid-Cap Fund	6,00,000	13,05,000	2.18X	0.75%	31.71%
Quant Focused Fund	6,00,000	12,08,000	2.01X	0.76%	28.46%
Parag Parikh Flexi Cap Fund	6,00,000	11,30,000	1.88X	0.56%	25.68%
Kotak Equity Opportunities	6,00,000	10,89,000	1.82X	0.53%	24.09%
Edelweiss Large & Mid-Cap	6,00,000	10,70,000	1.78X	0.47%	23.38%
Mirae Large & Mid-Cap	6,00,000	10,56,000	1.76X	0.62%	22.81%
Canara Robeco Emerging	6,00,000	10,17,000	1.70X	0.60%	21.25%
PGIM India Flexi Cap Fund	6,00,000	10,11,000	1.69X	0.41%	20.96%
Edelweiss Large Cap Fund	6,00,000	10,08,000	1.68X	0.78%	20.90%
Sundaram Focused Fund	6,00,000	10,00,000	1.67X	1.16%	20.55%
Kotak Bluechip Fund	6,00,000	9,88,000	1.65X	0.59%	20.06%
Canara Robeco Bluechip Equity	6,00,000	9,82,000	1.64X	0.52%	19.82%
DSP Flexi Cap Fund	6,00,000	9,74,000	1.62X	0.73%	19.46%
SBI Focused Equity Fund	6,00,000	9,46,000	1.58X	0.77%	18.29%
Mirae Asset Large Cap Fund	6,00,000	9,16,000	1.53X	0.54%	16.97%
Motilal Oswal Focused Fund	6,00,000	8,93,000	1.49X	0.94%	15.91%
Axis Blue Chip Fund	6,00,000	8,79,000	1.47X	0.66%	15.26%
UTI Flexi Cap Fund	6,00,000	8,50,000	1.42X	0.90%	13.93%
Axis Focused 25 Fund	6,00,000	8,31,000	1.39X	0.77%	13.00%

Data Source: Value Research

Before we go into the key takeaways, here is a quick practical point to illustrate the difference between CAGR and XIRR. The third fund in the above rankings, Quant Focused Fund, has doubled the money in 5 years. If you look at CAGR returns, then by the basic Rule of 72, the CAGR returns should be around 14.4%. However, the actual XIRR returns in this case are 28.46%. That is because the XIRR gives appropriate weightage to each instalment of SIP and to the timing of each instalment, which makes it more accurate. Let us now turn to the key takeaways from the top-20 ranked SIP funds.

• If you look at the choice of funds, the entire universe has been considered. Obviously, equity funds have come out at the top, largely because they have been the best performers over the last 5 years. Also, the SIP has helped to smartly capture the volatility in the market to their advantage.
• In terms of the mix of the categories of equity funds, the top 10 funds are largely dominated by either flexi-cap funds or large & mid-cap funds. The message seems to be that a combination of stocks across sectors, themes and capitalization gives a much better opportunity at rupee-cost averaging for investors and enhances returns.
• If you look at the top funds in terms of XIRR returns, then the returns range from 32.64% on the upside and 13% on the downside. Even the SIP fund ranked 20th in the list, has managed to give better returns than most of the debt or hybrid or even index products would be able to offer. That is an important perspective from a portfolio perspective.

Having seen the best performers in terms of SIP returns, let us turn to the practical aspects like how to identify the best SIP and the factors to consider before zeroing in on an SIP plan.

INVESTING IN THE BEST SIPS – PROCESS FLOW

Now comes the next practical question; once we know the best SIPs available in the Indian context, how do we go about choosing the SIPs and investing in them.

• Even at the risk of sounding cliched, you must start with a financial plan and fit these SIPs into your goals. Typically, you should have a SIP designed to meet specific goals by earmarking, either part of the SIP or the entire SIP, for the said purpose. The financial plan will decide your asset allocation and how much you can allocate to SIPs.
• Now, for the more routine part. Before you start the SIP, you need to ensure that your KYC (know your client) formalities are completed or updated. Once that is done, you can opt either for a direct plan online or even go through a broker an opt for a regular plan. The choice will be based on the extent of hand-holding you require.
• Once the SIP account (folio) is created and registered, it is an automatic process and gets debited on a monthly basis or any other period that you may choose. You can also fine tune your choice by opting for a step-up SIP or instead opting for a flexible SIP, based on your needs.
• The question is how do you choose the fund to do your SIP. The ranking on XIRR can be a starting point. You can further fine tune the search based on low total expense ratio (TER), and sufficiency of AUM. One more test you can apply before zeroing in on the fund is to check rolling returns for a period of 1 year, which portrays consistency.
• An important factor to consider when choosing your SIP is to look at risk adjusted returns. For equity funds, there are some well accepted measures like the Sharpe Ratio and the Treynor Ratio. These measures will tell you if the fund manager is taking on inappropriately high risk and whether the returns justify the risk taken.
• When it comes to equity fund SIPs, the fund manager background and the fund team stability also matters. Equity fund performance is about consistent strategy. That is not possible if the core fund management team comprising of the CEO, CIO and fund managers keep changing on a regular basis.
• Look at the portfolio disclosure to ensure it is adequately diversified. We are talking of diversification in terms of sectors, themes, capitalization; as well as duration and asset quality in case of debt fund portfolios. Also, look at the portfolio of these funds, with reference to your existing equity portfolio across direct equities and equity funds.
• Finally, the golden rule; an ounce of transparency is worth a pound of A fund with transparent communication about its strategy, holdings, and future plans is able to gain your trust a lot easier. Be cautious about funds that have had a history of not putting the interests of unitholders on top.

Based on the above parameters, you can complete the SIP formalities and specify SIP contribution, SIP tenure and other related data points.

BIG LESSON: ALIGN THE CHOICE OF SIP TO YOUR GOALS

We spoke about this in the beginning, but we are reiterating here as a separate point due to its importance. While all the factors we discussed above are find, the most important consideration should not be the best mutual fund SIP; but the best mutual fund SIP suited to your unique needs. That means the SIPs you choose must be aligned to your needs and tailored to your specific needs. If you are planning a long term goal like child’s education at the end of 18 years, then the specific consideration are the best risk adjusted returns, avoiding concentrated portfolios, tax efficiency to reduce leakages and liquidity at the right to be able to meet the major costs.

The next key point in choosing the right SIP is to align the timing of the goal with the type of SIP. For instance, a long term goal like retirement or child’s plan after 15-20 years must be largely supported by equity funds. For goals that have a time frame of 5-8 years, you can look a combination of equity funds, index funds, hybrids, and a small part in debt funds. This will help you combined the best of alpha and stability. For very short term needs of under 3 years, you can largely rely on debt funds and liquid funds to ensure that the risk to capital is reduced to the bare minimum. Look at all your overall portfolio of all mutual funds across lumpsum investment and SIPs to check if the portfolio is diversified at a macro level.

Since the choice of SIP is aligned to your specific goals, it is also a good idea to run a check of whether these funds live up to your risk tolerance. Here risk appetite must be understood as distinct from risk tolerance. Risk appetite is based on your psychology, but risk tolerance is determined by your actual financial condition. Give more importance to risk tolerance. Finally, a portfolio of SIPs can deliver the results only if it is reviewed on a periodic basis. Some funds may be doing well, others may be lagging; and that calls for some repositioning of funds. Also, new developments in the market (like taxation of liquid funds) may induce you to shift to arbitrage funds, which hare more tax efficient. With this, you are good to go.