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NEW DELHI (Reuters) - India's diversified stock funds posted their strongest gains in five months in June, reversing a bleak performance in May on improving global sentiment and domestic reform hopes, scoring big gains in the capital goods and financial sectors.
Fresh measures to ease the euro zone crisis, signs the government may revisit economic reforms and efforts to provide clarity on a tax proposal that had panicked foreign investors helped push the benchmark BSE Sensex up 7.5 percent in June to a near two-month closing high.
Diversified equity funds, which form the largest category of mutual funds in India by number and assets, returned an average 6.01 percent in June, data from fund tracker Lipper, a Thomson Reuters company, showed. In May, these funds fell 5.65 percent.
"The worst appears to be over and probably July will be a month of consolidation," said R K Gupta, managing director at Taurus Mutual Fund, adding that the outlook has improved from previous months.
"There is limited downside risk now".
After taking charge of the finance ministry, Prime Minister Manmohan Singh managed to restore some market confidence, saying he wanted to revive the economy's "animal spirit" and would make investor sentiment a top priority.
Even though rating agencies Standard & Poor's and Fitch have threatened to downgrade India's rating to junk on worries about slowing growth and policy inaction, lower stock valuations prompted brokerages like JP Morgan and Deutsche Bank to upgrade Indian stocks during the month.
Sectoral bets by some Indian money managers also helped mutual funds in June.
Gains in the capital goods sector, which according to Morningstar India data accounted for over 10 percent of mutual funds' assets by end-May, supported net asset values as hopes for new spending on infrastructure helped the sectoral index jump 13.7 percent.
Exposure to the financial services sector, fund managers' top sectoral bet in India with an allocation of nearly 22 percent, also aided performance, with the BSE banking index rising 9.4 percent.
Sector funds that bet solely on the financial services sector generated a return of 9 percent for the month.
June's rally was mainly driven by large-cap stocks, but the BSE mid-cap and small-cap indexes still posted solid gains to rise more than 4 percent. Morningstar India data showed funds held 41 percent of their assets in mid- and small-cap stocks by end-May.
The top performing funds in June were UTI Banking Sector Fund and Goldman Sachs Infrastructure Exchange Traded Scheme, both returning more than 10 percent.
Among other schemes, fixed income funds that invest in government securities generated a 0.69 percent return on an average, while India's gold ETFs ended almost flat.
Reporting by Aditya Kalra; Editing by Richard Pullin