For Nilesh Shah, it would have been yet another speaking engagement at an investor meet — if it weren’t for the timing. This time, the mutual fund industry was banking on its star speaker to come to its defence. And the chief investment officer and deputy managing director of ICICI Prudential Mutual Fund wasn’t about to let them down. The liquidity crisis in the equity market was a black swan event — it couldn’t have been predicted, he said. “Investors should hold on to equities as this is the only asset that generates returns over the longer term.”
Not too many investors might immediately question Shah’s assertion. After all, over the last decade, the performance of equity fund managers has been unquestioned. In the last ten years (November 1998 to November 2008), the Indian market has grown by an average 12 per cent annually, the boom years and the earlier sluggish period all told. During the same period, fund managers have generated a return of 18-20 per cent for diversified equity funds, a good proxy for the broad market.
But that’s just half the story. Things have been changing over the last five years. Beating the market isn’t a cakewalk these days. And the out-performance of a fund relative to its benchmark - also known as alpha - has been falling gradually.
Sample this: overall, fund managers have given a return of 15.33 per cent over the last five years while the markets returned 13.5 per cent. Here, if we add a 2 per cent dividend redistribution that an index fund investor can benefit from, then the returns from the market will be 15.5 per cent on par with any active fund manager.
But then averages can sometimes be misleading — especially since a clutch of fund houses and their star fund managers have done far better than the average. Let’s look at a set of diversified equity schemes managed by a line-up of the smartest fund managers in the country. For the sake of the experiment, we choose Prashant Jain of HDFC MF, Sukumar Rajah of Templeton, Sunil Singhania of Reliance, Prashant Kothari of ICICI Prudential, Anup Maheshwari of DSP BlackRock MF and the duo of Anoop Bhaskar and Sanjay Dongre from UTI.
Here is what the data revealed. These star fund managers managed to return 17.5 per cent over a five-year period—a good 200 basis points higher than the average. But then, as the index fell by 52 per cent in the last one year, the funds managed by stars also dropped by a similar figure. The overall mutual fund industry fell 54 per cent.
So, are the glory days of fund management over? Or is it just a temporary blip in performance? Across the board, mutual fund investors are asking crucial questions about performance. What shield have fund managers provided their investors over those who invested directly in the stock markets? Why were funds unable to read the present crisis and go into cash when the markets were hovering at unrealistic highs? After all, weren’t these the folks who were supposed to have superior knowledge? They simply haven’t delivered, feel many investors.
The mutual fund industry is well aware that it has its back to the wall. “It is time to build credibility one more time. We have gone back to the days of the early Nineties where there was so much mistrust about mutual funds amongst the people. We are entering the dark ages and this time, it is not going to be easy,” says a fund manager. He feels that within a year’s time the industry has regressed into a state it was in almost a decade ago.
So here’s the moot point: can the industry really bounce back?
Lessons from the past
The clues lie in how fund managers managed to beat the Street by a wide margin in the past. Sanjoy Bhattacharya, a former chief investment officer at HDFC Mutual Fund says that when the overall alpha generated over ten years is considered, it is seen that active fund managers have generated a return of 20 per cent annually while the Nifty is hardly 12 per cent. "Thus it is not because of the fact that Indian fund managers are geniuses but due to the fact that the Indian market is highly inefficient and this will continue to (be) so,” he says.
Simply put, that means market prices in India have more anomalies at a given point of time, than say, in developed markets. Information does not get quickly adjusted in the Indian markets and thus there is inefficiency in the market for fund managers to exploit. A big investor or a fund manager can have extra information about a company related to its exports or product development that the rest of the market does not have. Or she may know beforehand the order-book position of a company that is exclusive information.
Blue chips and other large cap stocks, which are keenly watched by the investor community, suffer less from this inefficiency than midcaps that have a lesser level of tracking. Typically, a small number of traders can have large influence on a midcap stock than on a large cap. News leaks and event-driven rallies create imbalances in stock prices. On the flip side, liquidity can dry up more quickly on midcaps than large caps. For liquidity and relatively better price efficiency, large caps are naturally the better bet.
As star fund managers start to show performance — and their fund corpus starts to increase — the fund is forced to maintain a very liquid portfolio so that it ensures a smooth exit. Besides, it keeps the operating cost for managing the portfolio down. Here again, the large cap stocks tend to be more suitable than mid cap stocks. So large funds — run by star fund managers — are forced to skew their portfolio towards large caps.
Now, that has a huge impact on returns. High return stocks, where the fund manager would perhaps have extra information on the company, also suffer from low liquidity. Thus, small funds take the risk of investing in mid cap stocks.
So how does this phenomenon impact the star fund manager’s investing strategy?
Promise vs. philosophy
Every fund has a philosophy or an objective. Under pressure to deliver higher returns than the benchmark, many funds start diverging from their philosophy of long-term investment.
In their frenzy to beat the markets, fund managers end up relying on short-term trading strategies. This basically means that they keep churning their overall portfolio to catch up with the latest trend in the market instead of holding stocks for the long-term. Portfolio turnover for all funds that have delivered more than 15 per cent over the last five years is less than 100 per cent.
This includes the top performing funds in the market. When funds end up competing for the same stocks in their portfolio, the returns of these portfolios start to show high correlation with each other. Top funds in terms of assets have a more than 90% correlation in terms of returns over the last five years.
So if a fund does well, its performance tends to get quickly dissected and other funds end up imitating its portfolio—sometimes at complete divergence from the fund’s original objective. For example, many infrastructure funds would have banks as the top sector or a 'Gen-Next' fund has a Hindustan Lever. Or, if you notice a power fund with Bharti Airtel as its best holding, it could merely be a policy to copy another successful fund.
Even brokerages got dragged into this intensely competitive environment. Sometime ago, a broker sought empanelment with a prominent fund whose fund manager was known for his ethics in investing. He was asked to send tips to the fund management team on a daily basis every evening as a price.
"Outside in conferences, the fund manager talks about long-term investment and Warren Buffet philosophy, but he wants to have tips on a daily basis. The portfolio turnover of these funds is very high. They deliver returns by taking higher risks and not through value investment. No wonder we are seeing these portfolios losing value in these market,” says the broker. He refused to fall in line and chose not to work with the fund.
“In a way, the cult of star fund managers and analysts are created by the media and distributors. These fund managers have gone wrong in the recent past yet they continue to increase the AUMs. Investors should look at creating wealth in the long-term and on strong fundamentals. Believing too much in fund managers may lead to behavioral biases,” says Parag Parikh who heads Parag Parikh Financial Services. While most funds behaved similarly, it is the star fund managers whom many investors trusted to perform better.
For the investors, it is often a tough call to make whether or not to be with a fund that defies its own long-term objectives to give higher returns. Hence, the question is a difficult one and the answer to it even more so, according to Nipun Mehta, head of private banking at Societe Generale India. Says Mehta: “The fund manager has changed his strategies to give higher returns to the investor. This is right. But getting into short-term trading or defying the basic goal of the fund is wrong.”
Over the last few years financial markets have gone across a lot of change. Mutual funds were based on a simple concept of diversification. Thus uncorrelated stocks should be able to generate higher returns with lower risks. Over the last two years, asset classes including foreign exchange markets, gold, real estate, stocks, oil and commodities have moved up together. This has defied the entire logic of portfolio building. Fund managers are yet to come to terms with this phenomenon. A lot of them have moved away from the traditional financial theories to behavioral finance as they feel that this new field will give them better answers to understand the market. Though this may be true that new fields will create new inroads, fund managers need to realise that all this will only make markets efficient and difficult to beat.
Mutual funds are not soap operas. There is no need for stars here. Neither there is any guarantee that celebrity fund managers will bring in superior returns. Given that they have not been able to shield their funds from colossal losses in recent months, star fund managers are sure to lose some of their aura. But there is one star that will always reign supreme on the horizon of investment. It is called prudence.
Like this article? Download here
Comments
0 comment