Mention the word 'Equity' to the average investor and chances are that you will get more than a raised eyebrow. Horror stories of investors losing all when the technology bubble burst in the year 2000 will fly thick and fast. Haven't you learnt anything yet -the angst-ridden voice will ask? Two scams and a long bear phase later, where does the 30-share BSE Sensitive Index stand today--at about the same level it was in December 1993. The uncertainty, the heartburn, the hours spent analyzing reams of data with little result are enough to make equity seem a four-letter word. Forget it, says the investor; I am better off with debt.

Indeed, since the year 2000 equity market sell-off, retail investors have been staying off both equity and equity mutual funds. The CRISIL Index tracking diversified equity funds, the CRISIL Fund-eX, was down over 17% in the two years ended October 2002, when the BSE Sensex touched a low of 2828. The best performing diversified equity fund in the two-year period gave an annualized return of just over 12%. The worst performing fund yielded a return as low as almost (-)40%. The average annualized return in this category was (-) 11.75%.
With interest rates being cut in quick succession, debt markets scaled new peaks every month. Mutual Fund investors, with a conservative to moderate risk profile, showed a distinct preference for debt mutual funds in the past two years. The average annualized return of all debt funds over the two-year period ending October 2002 was as high as 14.55%.
The RBI cut interest rates again in April 2003 and debt funds continued their winning streak even after October 2002. Top performing debt mutual fund schemes provided returns ranging between 17% and 21 % for the year ended May 21, 2003. However, the RBI has indicated that it may consider more 'stable' interest rates once inflation is between 5% to 5.50%. What will be the impact on debt fund returns? These are expected to range between 10% to 11% in 2003, lower than returns in 2002.

Equity — Brightening Prospects
Meanwhile, there has been a marked improvement in the state of the equity markets. After remaining subdued for most of 2002, the markets have rallied nearly 700 points from their low in October 2002. There have been several factors, which have led to this rally. The earlier-than-expected end to the US-Iraq conflict, limited impact of SARS in India, continued strong corporate performance in 2003 and a better monsoon expected in 2004, have seen equity markets in an uptrend. Also with interest rates at historically low levels and dividend yields in an attractive 5%-10% range, the focus has shifted once again to equity.
A key factor fuelling the equity markets has been FII inflows, which have grown unabated. In the period from October 2002 to early June 2003, FIIs have made net purchases of over $ 800 million in equity on a cumulative basis. The expectation is that the figures would register a 'considerable increase' during June-July 2003. With India talking peace with Pakistan and a good monsoon in the offing, international investors are taking a second look at Indian equity markets. There is particular interest from dedicated emerging market fund managers who have a long-standing overweight of 6.50% on India compared to a benchmark Morgan Stanley Composite Index (MSCI) Emerging Markets Fund index weighting of 4.90%. International Emerging Market funds such as Emerging Markets Growth
Fund, Emerging Markets
Trust and Vonotobel Fund Emerging Markets Equity have more than 11% of their assets in Indian equities.
Despite disappointing guidance by leading Indian tech companies, slowing down of reform process and the soft-pedaling on the VAT issue, 68 of 91 emerging market funds remain overweight on India. Also current average valuation for the Indian equity market at about 10 times 2003 earnings, although not that attractive relative to some other South Asian markets, are definitely at more realistic levels compared to those prevailing in 1999 and 2000 at the height of the tech boom. Funds are being re-allocated for the South Asian region and India may be a major beneficiary. FII confidence is also based on the fact that the Indian economy may grow at 6% in 2004 and is a play on the Indian outsourcing story.
The prospects for equity markets going forward are, therefore, positive. Investors have largely discounted all the negative factors prevailing during March-April 2003 such as rising oil prices, recession in the US and other economies. The US markets have also rallied smartly after the end of the US-Iraq war with both the Dow and Nasdaq hitting their 1-year highs. The US Federal Reserve Board may again cut interest rates that may revive the US economy. The markets have an upside potential of nearly 200 points from current levels, albeit with some corrections on the way.
The current rally, which began with refinery and banking stocks touching dizzying highs, became a more broad-based rally spreading to mid-cap stocks, characterized by value buying rather than playing on growth. Since April 28, 2003, the broad based BSE 500 has risen over 19%. Leading brokerages confirm that not only have domestic institutions participated in the rally but also the elusive retail investor may well be back in the markets. Leading mutual funds have also seen a jump in application from retail investors for equity schemes.
Diversified equity mutual funds have shown a sharp improvement in returns over the past six months. In the six months ending June 04, 2003, the CRISIL Index tracking equity funds has risen an impressive 12.77%. The top performing equity mutual fund returned a whopping 43.52% or over 100% on an annualized basis during this period. The worst performing fund returned (-)22.79%. The average absolute six-month return of diversified equity funds was a decent 12.86% or over 25% on an annualized basis!

Portfolio Strategy
In this scenario, what should your strategy be? It would be a good time to diversify one's portfolio to include equity mutual funds. The benefits of diversification are that while your risk exposure from a particular asset may not be very high, it would also give you the opportunity of participating in the party in the equity markets-which may have just begun -- in a relatively safe manner (than investing directly in the stock markets). The following table provides a recommended portfolio mix of Cash (including Savings account and Liquid Mutual Funds) to meet immediate liquidity needs, Debt (comprising debt mutual funds and small savings) to provide moderate returns at a reasonable risk level, and equity mutual funds to provide a window for higher returns at a somewhat higher risk level.
The allocation is provided for six different risk levels ranging between very conservative to very aggressive. The investor should first choose the risk level he is comfortable with and then rebalance his sportfolio to arrive at the recommended mix.

Portfolio Strategy
Asset Classes/Options	Conservative		Moderate		Aggressive
	Very Conservative	Conservative	Conservative Moderate	Moderate	Aggressive	Very Aggressive
	% Exposure to Total Portfolio	% Exposure to Total Portfolio	% Exposure to Total Portfolio	% Exposure to Total Portfolio	% Exposure to Total Portfolio	% Exposure to Total Portfolio
Cash	20%	10%	10%	10%	10%	5%
Investment Options :
Savings A/c	8%	3%	2%	2%	1.50%	1%
Liquid Funds	12%	7%	8%	8%	8.50%	4%
Debt/Miscellaneous	80%	80%	70%	60%	50%	42%
Investment Options :
Debt Mutual Funds	50%	51%	51%	46%	34%	30%
Small Savings Schemes	30%	29%	19%	14%	16%	12%
Equity	0%	10%	20%	30%	40%	53%
Investment Options :
Equity Mutual Funds	0%	10%	20%	30%	40%	53%

Asset Allocation rationale
For very conservative investors, we suggest that they continue to maintain 80% of their portfolio in debt funds (50%) and small savings (30%) -- since the risk associated with these investments are lower. However, we recommend that investors, with a slightly higher appetite for risk, start adding equity mutual funds to their portfolio beginning with 10% for conservative investors. Very aggressive investors may allocate as high as 53% to equity mutual funds. These allocations are indicative only and an individual investor may vary the allocations depending upon his personal preferences and financial position. The returns from the above portfolios range between 6% per annum for very conservative investors to 11% per annum for very aggressive investors. While the returns may not be spectacular, the risks associated with the above portfolios have been kept at moderate levels. This can be seen from the fact that even for very aggressive investors, exposure to debt funds and small savings has been kept at 42%. This is to provide the maximum benefits from diversification to an investor. An investor may increase his exposure to equity funds in the short to medium term, beyond recommended levels, with clear targets for profit booking levels, if higher returns are sought.

Investment Style
When investing in mutual funds, the investor should make systematic investments (SIP) i.e. invest small amounts every month rather than invest a large amount at one go. As the NAV goes up and down every month, even expert investors find it difficult to predict a single good time to enter a fund. Therefore, investing at one go may not yield the best results. However, investing systematically results in the rupee cost averaging benefit to an investor i.e. reducing the weighted average cost of acquiring units in a fund. SIP works well in case of equity funds due to their volatility as shown below:
As can be seen above, even if the investor invested Rs. 18,000/-, at one-time, at the average NAV during a 9-month period, (in the case NAV is falling), the cost would be higher (8.26) than if he invested Rs. 2,000 per month (average cost 8.13). The results are the same when the NAV is rising. Average acquisition cost of a one-time investment is 12.09 during a
9-month period, compared to 11.84 when systematic investments are made.

Sector Play
Sectors that are expected to do well in 2004 are Oil & Gas (particularly refineries), aluminum, electrical equipment, textiles, auto and auto ancillary stocks. Funds having significant exposures to these industries in their portfolios, would gain the most from the anticipated up move in the markets. Reducing exposure to debt funds and increased allocation to diversified equity funds is a prudent strategy. While this may raise the risk level for conservative to moderate investors, given the favorable outlook on returns from equity as an asset class, the increased exposure is strongly recommended at this stage. Further, investment in a fund
that is well diversified reduces the risk associated with exposure to a single sector.

Oil & Gas (Refinery focus)
The April 2002 dismantling of the Administered Price Mechanism (APM) exposed domestic refineries to variations in international prices of crude oil. Crude oil prices had inched up from a low of around $ 26 per barrel in November 2002 to a high of around $ 36 per barrel in February 2003 due to the US-Iraq conflict. Since then, crude prices have fallen to currently about $ 27 per barrel. This will positively impact the refining margins of companies like Indian Oil Company, HPCL, BPCL and Reliance in the first half of 2004. Crude oil prices are forecast to rise slowly in the second half. However, companies should end 2004 being net gainers on this account since at no point are crude prices expected to break $ 33 per barrel. Add to this the government finally speeding up the disinvestment process in HPCL and BPCL and there is little wonder that stocks in this sector have aroused significant investor interest. Petrochemical majors such as Reliance are also expected to benefit from the upturn in the petrochemical prices
cycle.

Aluminium
Aluminium prices have been on an uptrend since September 2002 mainly due to increased demand from China, where constraints on domestic production have led to increased demand for imports. While the first half outlook on domestic demand in India remains bearish, improving prospects for automobiles and the electrical equipment industry, beginning in the second half of 2004, are expected to boost prospects for majors like Hindalco and Nalco. Further, these companies are planning a renewed thrust on exports, which would positively impact top line growth. Demand in the extrusions segment remains buoyant due to healthy growth in the domestic construction industry.

Electrical Equipment
The sector grew at 5.20% in 2003, up significantly from 2.70% in the previous year. The main drivers were switchgears (+11.30%) and transformers (+6.90%). Volume growth was impressive with low voltage circuit breakers up 33.10%, miniature circuit breakers up 13.80% and high voltage circuit breakers up 9.30%.
While the second half of 2003 showed slower growth as opposed to the first half, due to lower sales of energy meters and transmission line towers, the outlook for 2004 is positive as export growth is expected to be in the region of about 25% aided by reconstruction contracts in Iraq. The electrical equipment sector as a whole is expected to grow at 6% in the current financial on the back of factors such as the passage of the Electricity Bill and government initiatives such as the accelerated power development programme (APRDP). Majors like BHEL, L&T and Crompton Greaves are expected to be the main beneficiaries.

Textiles
Textile scrips such as Arvind Mills, Bombay Dyeing, Nahar Spinning, Mahavir Spinning and Super Spinning caught the fancy at the bourses with the anticipated dismantling in 2005 of the quota system currently imposed under the Multi Fiber Agreement. This is expected to significantly open up the export market for Indian companies, which at present face severely restricted markets for exports. Higher international demand, improved product-mix, better capacity utilization and lower interest rates are some of the factors, which have led to improved performance. The Budget 2003 also came out with a special package for the sector including cuts in excise duty for polyester filament yarn and cotton garments.

Auto & Ancillaries
The main play on the automobiles sector is the monsoon, which is expected to be better than in 2003. If the monsoon is good, domestic demand, particularly from the rural sector will receive a boost. This will especially favor two wheeler manufacturers such as Hero Honda, TVS Suzuki and Bajaj Auto. However, four wheelers have also been helped by an 8% cut in excise duty in Budget 2003 and there will be higher demand from the rural sector as well if there is an above average monsoon.
While auto ancillary majors like Bharat Forge, Motherson Sumi Systems and Exide would benefit from improved domestic demand from auto majors, the outsourcing story remains a major positive for this sub-sector with global original equipment manufacturers set to outsource auto components from India as international automobile majors like General Motors and Ford, facing a slowdown in sales, undertake cost cutting exercises.

Choosing a Mutual Fund
Having decided to invest in equity funds, the investor is faced with the problem of choosing between two equity funds. One way to decide between two funds is to look at the industry exposure of the respective funds. Thus, if a particular fund has invested in sectors, which are expected to do well, the investor may do well to choose such a fund over another, which is not so well positioned. This is a good strategy especially if one has a short to medium term perspective i.e. about 6 months to a year. Five funds that an investor could consider, on the basis of their current industry exposure, are the following:
Alliance Basic Industries Fund The scheme is an equity sectoral scheme concentrating on core industries. Its one-year return is a huge 40.18% vis-à-vis the benchmark BSE Sensex 1-year return of 3.23%. Total assets under management are Rs. 81.20 crores, with minimum investment of Rs. 5,000/- and an entry load of 2%. The scheme has no exit load. Top 5 industries the fund is exposed to are Banks (36.21% of NAV), Refineries (18.02%), Electrical Equipment (8.71%), Automobiles - 4 Wheelers (6.23%) and Steel And Steel Products (5.48%). The scheme is, however, fairly volatile with a standard deviation of 0.23.

Reliance Vision Fund
An open ended General Equity scheme with holdings mainly in Miscellaneous sectors (14.41%), Pharmaceuticals (8.17%), Banks (7.93%), Electrical Equipment (4.51%) and Cigarettes (3.85%). The one-year return is a healthy 28.31%. The minimum investment in the scheme is Rs. 5,000, with an entry load of 2% and no exit load. The scheme has Rs. 112.93 crores under management. The scheme has a low volatility of 0.19 (Standard Deviation)

SUN F&C Resurgent India Equity Fund
A small equity scheme managing only Rs. 1.06 crores with a high minimum entry threshold of Rs. 1 lakh, an entry load of 2% and no exit load. The scheme has a high one-year return of 27.45% but returns are highly volatile as the standard deviation is 0.27. Top 5 sectors include Refineries (15.79%), Electrical Equipment (13.39%), Automobiles-4-Wheelers (10.16%), Miscellaneous sectors (9.65%) and Shipping (7.98%).

Prudential ICICI Growth
This General Equity scheme by the industry leader is exposed mainly to Banks (17.37%), Automobiles - 4 Wheelers (14.74%), Refineries (11.42%), Computers - Software (10.10%) and Electrical Equipment (9.82%). Scheme returns are a modest 8.67% with a standard deviation of 0.21. The scheme manages Rs. 293.79 crores and has a minimum investment of Rs. 5,000. The scheme has no exit load while it has a graded entry load structure ranging between 1% on investments above Rs. 3 crore and 2.25% on investments below Rs. 10 lacs.

Prudential ICICI Power
An equity scheme focusing on the power sector holds companies in the Banking sector (20.46%), Electrical Equipment (18.48%), Automobiles-4 wheelers (12.35%), Steel and Steel Products (10.24%) and the Refineries sector (6.93%). The return is fairly high at 23.52% but so is the volatility at 0.23. The medium sized fund, with assets under management of Rs.73.39 crores, has a minimum investment of Rs. 5,000, no exit load and a graded entry load structure similar to the pure equity scheme by Pru-ICICI.

Consistency as a criteria
Other investors may have a longer-term perspective (2-5 years) and could look for consistency of returns or alternatively the risk associated with the competing returns from various schemes. The fund that generates a higher return with a lower level of risk is often superior to a fund that may generate a higher return from time to time but is more volatile in the longer term. Five schemes with reasonable long-term returns and relatively low risk (standard deviation) are profiled below:

DSP Merrill Lynch Equity Fund
A small general equity scheme, managing Rs. 22.43 crores, returned 11.85% (annualized) since inception (compared to a BSE Sensex Benchmark return of (-)1.05%. The scheme has a low volatility of 0.17. The minimum investment in the scheme is only Rs. 1,000, with an entry load of 2% and no exit load.

Franklin India Bluechip Fund
A large General Equity scheme, with Rs. 570.62 crores under management, has returned a steady 20.12% since inception. Scheme volatility is somewhat higher at 0.19. One needs a minimum Rs. 5,000 to enter the scheme, which has a front-end load of 2% and no back-end load.

Franklin India Prima
Another medium-sized equity scheme by Templeton, managing Rs. 185.83 crores, is high on consistency -- having a very low standard deviation of 0.16 while returning a decent 14.88% since inception. With a minimum investment of Rs. 5,000, the entry load is 2% while the scheme has no exit load.

Sundaram Select Midcap
This equity scheme focuses mainly on the mid-cap stocks and manages only Rs. 8.74 crores. The small size has helped it in returning a huge 31.45% since inception. In terms of volatility, the scheme is about average with a standard deviation of 0.18. The entry load is 2% and the minimum investment is Rs. 5,000. With effect from June 12, 2003, investments above Rs. 25,000 would not attract any entry load.There is no exit load.

Zurich India Equity Fund
This largish scheme from Zurich (managing Rs. 351.64 crores) has provided average returns since inception of 13.38% with the volatility also being in the average range of 0.18. The minimum investment is a low Rs. 1,000, with no exit load and an entry
load of 2%.

The smart money is moving towards equity funds-the question is - are you?