Wednesday, July 2, 2008


There has been a lot of mutual fund bashing going on recently, with investors upset that fund managers have not been able to protect investors in the current downside. I am also guilty of criticizing these guys in a previous post. Everyone wants a scapegoat when things go wrong. But I now think we ought to take a relook at what went wrong with the decisions that fund managers made and were they entirely responsible for not saving investors from the terrible erosion in values that has taken place. I would not go so far as to say that there was nothing they could have done to protect investors, but given the circumstances it was extremely difficult to act any other way.

It has been said that funds did not take profits at higher levels. I think that, even though funds did book profits, by mandate an equity fund has to have a majority of its corpus in equity. Being in another asset class is not a call for a fund manager to take. When investors have given him the money to deploy in shares it means that they have studied the implications of having a portion of their assets invested in equity, with the associated risks. If investors had indeed wanted fund managers to periodically rebalance their portfolios, they should have invested in the various asset allocator mutual fund options in the markets or, opted for the dividend payout option. Let's face it, it was our greed that got us to invest in pure equity funds and not sell the units at higher levels.

Another point people make is that fund values have fallen more than the benchmark indices, which is quite true. But one has to realise that however diversified a fund might be, it's portfolio is still quite concentrated when one compares it to its benchmark index. The concentration may not be in the number of scrips held, they may be quite diversified but a large percentage of the fund's assets are concentrated in a few top holdings. Generally a large cap fund has about 45 to 50 % of its holdings in 10 stocks. This is exactly what enables an actively managed fund to outperform the indices when they go up. It is but natural that the converse should be expected to hold true on the way down. If the past 5 year track record of the top funds is compared with that of the indices, we find that the funds have hugely outperformed.

A criticism that I have also made in the past is that the fund managers were invested heavily in flavour of the month stocks like infrastructure and real estate. But as investors, our investment psyche is such that we generally look at how well funds have done over a 1 year period. We then invest in last year's better performers. In doing so, we do not allow fund managers to take a longer term call. If investors focussed on 3-5 years returns, I feel fund managers would be emboldened to avoid hot stocks which are overpriced and concentrate on value instead. Whichever way one looks at it, a fund has to have assets under management, to stay in the business. Assets can only be garnered by showing fantastic returns in the short term.

I have recently seen the concept of SIP' being attacked as not being a suitable investment strategy. I would like to differ on this. ICICI Prudential Growth Plan, not one of the top ranked funds, has given SIP returns of 18.57 % over a 3 year period and 29.60 % over a 5 year period. I have deliberately not included a top performing fund, in order to give readers an idea of the average fund returns. Returns are as on 31.05.08. Anyway, the best method of judging a SIP is when the markets have recovered after being down for a while. This is where the benefits of Rupee cost averaging works out. If the markets have fallen precipitously as they have done recently, investors do not get time to accumulate enough units at lower levels. The error in estimating the efficacy of this strategy is compounded when the lowest NAV' are used for calculating the returns. In my view SIP is an extremely efficient and simple way to create wealth in stock markets. If an investor sticks to his SIP plan, I am sure that when markets recover, he would be amply rewarded for his discipline and persistence.

The above does not in any way absolve fund managers from their duties as guardians of public wealth, but we, as investors, need to realise that they are after all human and are subject to the same failings as we are. They have done an admirable job in the past in beating market returns and can be expected to do so in future, if we allow them some leeway and time to get their act together again.


Uma said...

well-researched, well-written and a refreshing viewpoint! kudos.

Uma said...

I'm starting to see sensex at 10K...but there are too many stocks such as ACC that never took part in the rally. I hope, they don't crack further. Honestly, Mahendra, my faith in fundamental buying is going, going, gone :(

Mahendra Naik said...

Hi Uma,

Why so pessimistic? It's true that lots of stocks have not performed. Cement, as you have rightly mentioned is one of them. But if you have diversified your portfolio hedging it with IT, Pharma, FMCG etc, you should do ok. Even cement would have done well without the Govt breathing down its neck to restrain prices. Such is our polictics. When you are doing well everyone wants a cut and when you do badly, no one wants to support.


Most fund managers under perform the indexes.