For equity funds, Jan was the best month in 32

Diversified stock funds posted their best monthly return in nearly three years in January as a sharp rise in key stock prices and exposure to sectors such as financial services pushed up net asset values.

Diversified funds returned an average 11.68% to record their best monthly performance since May 2009, data from fund tracker Lipper, a Thomson Reuters company, showed.

The gains were about in line with the performance of the BSE Sensex, which clocked its strongest month since September 2010, gaining 11.3% on hopes of a revival in foreign fund inflows and an easing of monetary policy.

“Interest-rate sensitives rallied very strongly during the month and funds having higher exposure to them outperformed,” said Dhruva Raj Chatterji, senior research analyst at Morningstar India.

Mid- and small-cap stocks also aided fund performance in January. The BSE mid-cap index rose 14.35% and the small-cap index 16.45%, outperforming their larger peers.

Small and mid-cap stocks accounted for more than a third of diversified fund assets as of December 31, Morningstar data showed.

Bets on the financial services sector, which accounted for 20% of assets at end-December, also paid off as the BSE banking index surged by nearly a quarter in January.

However, Morningstar data showed an overall cash allocation of 7.2% in December, the highest since February 2011, possibly dampening the performance of some funds.
   
"Mid-cap funds had higher cash in their portfolios compared to large-cap funds," Chatterji said. "Even though equity funds did well in January, a number of them underperformed their benchmark indices during the month."

Funds focusing on the banking and financial services sector topped the charts in January, registering average returns of 23.74%, about in line with banking index's performance.

The Reserve Bank of India's decision to cut the cash reserve ratio, or the proportion of deposits that banks must keep at the central bank, by 50 basis points on January 24 boosted the banking sector and raised hopes that the central bank might soon start to cut its key policy rate.

Stronger-than-expected results from private sector lenders including HDFC Bank and Axis Bank also supported sentiment.

The UTI Banking Sector Fund was India's best performing fund in January, with a return of 26.2%, followed by the Goldman Sachs PSU Bank Exchange Traded Scheme, which returned 25.7%.

"Such funds are likely to do well in the near future," said RK Gupta, managing director at Taurus Mutual Fund. "The banking sector will remain good in coming months."