In our opinion, HDFC TaxSaver is a superior choice among its peers.

When manager Vinay Kulkarni took the helm in Nov 2006, the fund had built a strong track record since its Dec 1995 inception under the guidance of various fund managers. Although Kulkarni started off on a lacklustre note, underperforming 86% of his peers in 2007, he has done quite well since. Further, he has built solid track records across a number of equity funds he has run over the years. He is backed by a strong and stable investment team that ranks among the best in the industry in our view.

Kulkarni plies a multi-cap approach for this fund, investing roughly 60% in large caps and the remaining 40% in small/mid-cap stocks. Like all managers at HDFC AMC, he places strong emphasis on understanding each business, and he has an inherent quality bias when investing in companies. His investments typically span a two- to three-year investment horizon; however, it isn’t uncommon for stocks to feature in the portfolio for significantly longer time frames. This is also borne out by the fund’s low turnover ratios (19% as of March 2010 and 30% as of March 2011).

We think Kulkarni’s focus on the long-term strength of a business is positive and complements his investment style. His willingness to take big sector bets is another aspect that distinguishes him from his industry peers—his investments tend to significantly differ from that of the benchmark index and category peers. We believe this is linked to the research-intensive approach and the caliber of the investment team. His large bets in the health-care sector since 2008, and also in financials in early 2009, substantiate this. Overall, we are fairly impressed with his investment style and superior execution of the investment process.

However, certain risks associated with the investment process need to be highlighted. Kulkarni tends to make big sector bets, often against popular consensus, and these can result in near-term underperformance. His valuation consciousness can also hold back the fund vis-à-vis peers when markets are rewarding speculative fare. The fund’s poor performance in 2007 when stocks in overheated sectors such as power utilities, real estate, and metals were the season’s flavor is a case in point. Kulkarni has traditionally refrained from taking cash calls. However, in Feb 2011, the fund had cash levels nearing 17% of the portfolio’s assets, which is on the higher side. Although this may be a temporary measure and can be partly attributed to large inflows in the fund, such elevated cash levels expose the fund to timing risk. Nevertheless, we believe that over longer time frames, when markets experience a cycle, the investment style and the manager’s expertise will hold the fund in good stead. The fund merits our Silver rating.