Watch your Fund investment even in a booming market
Nov 6, 2006
According to the Wall Street Journal, the US mutual fund industry is headed for another "explosive scandal" as the Securities and Exchange Commission (SEC) investigates 27 mutual funds for allegedly accepting hundreds of million dollars in kickbacks from contractors.
The latest scandal was triggered by a $21.4 million settlement with the SEC in September by Bisys Fund Services, which provides administrative services to small funds and those promoted by some banks. Wall Street Journal quotes the SEC as saying, "As a direct result of Bisys's misconduct, mutual fund investors unknowingly paid millions of dollars for marketing their funds." This was done through secret side agreements.
The scandal shows that even in a mature mutual fund industry, the regulator and a seemingly better informed class of investors usually lag behind money managers' tricks to hijack investors' rightful returns. India's mutual fund industry is riding the crest of a powerful three-year bull run. Consequently, most investors are happy with their mutual fund returns, because they are higher than what they would have earned by investing money in safe fixed deposits.
Fortunately, the proliferation of Asset Management Companies (AMCs) is slowly creating a distinction between better-managed funds and others.
The challenge is to choose your fund correctly. For instance, contrary to the Finance Minister's view that market intermediaries must set up Self Regulatory Organisations (SROs), the Association of Mutual Funds of India (AMFI) has emerged as a strong lobby that protects members and liaises effectively with the Securities and Exchange Board of India (Sebi). But it does not venture to self-regulate or check its members. In fact, AMFI does not even keep track of the industry's evolution. Neither AMFI nor Sebi (which clears every new fund offering, as well as mergers, acquisitions and closures) has a complete record of all mutual funds and schemes that existed in India.
This data is essential for studying "survivorship bias", which is the tendency for failed companies to be excluded from performance studies because they no longer exist and this skews industry studies by measuring only successful performers.
Investors who do not want to be blind-sided, as they were by trusting the giant Unit Trust of India for a quarter of the last century, need to look out for four issues.
First, is their chosen scheme really capable of delivering on its advertising promise? For instance, at the height of the IPO scam, Sebi cleared a Stanchart scheme that planned to apply for IPOs and flip them on listing to book profits for investors. At least that is what Stanchart officials told the media. Given that individual investors are more discerning about IPO investments, it remains to be seen how this will deliver. We recently saw a slew of 'rural oriented schemes', but it is unclear if they will find adequate investment options in this much-hyped sector, or are merely luring investors with a new gimmick? Also, will contrarian funds really dare to go contrary to the market in the middle of a monster bull run that shows no signs of flagging?
A second key question is, does the fine print on investment strategies meet the broadly stated objective of a scheme, or is aimed at empowering fund managers to play the market? When a fund calls itself a balanced fund, why is it heavily loaded in favour of equity? Why should a balanced fund want to change the 'balance' or investment mix at will, put your money in derivatives, commodities, indulge in arbitrage play or invest in overseas markets?
Several schemes are planned to capture specific sector growth, like retailing but quote banks, textiles, pharma companies and hotels stocks as potentialinvestments. A commodity fund (SBI Mutual Fund's Comma Fund) does not invest in commodities, only commodity related stocks. Or, check ING Vysya's three-year closed end fund, which has given itself the freedom to "continuously churn its portfolio", indulge in market timing, change equity exposure at will, invest 100 per cent or 0 per cent of the corpus in equity at its discretion and to trade in derivatives.
Doesn't this sound more like a super-aggressive hedge fund rather than a mutual fund? Strangely enough, the regulator has permitted it to position itself as a balanced fund. Is the booming market making the regulator complacent as well?
Third, does the index benchmark chosen by a scheme, match its objective and investment plans? Every fund benchmark's its performance to an index that is expected to represent its investment profile; it is supposed to be judged against that benchmark. But even in a booming market, fund managers repeatedly fail to beat benchmarks. Of the 126 equity diversified schemes launched between January and September 2006, 67 per cent failed to meet their chosen benchmark when the Sensex rose 28 per cent. Some even choose a deliberately low benchmark. For instance, why should a dynamic asset allocation fund be benchmarked against the Crisil balanced fund index, when it plans to invest in everything from derivatives to commodities and overseas markets?
Fourth, given the long term optimism about the Indian economy, index funds, which mirror a popular index and require very little 'fund management' seem to offer excellent returns over a longer term. The performance of the Sensex and Nifty show that. But although India has several index funds, which collect fatter than required fees from investors, these are the least promoted schemes because they offer little opportunity for churning, deviation and adventurism to fund managers.
In a rising market, losses caused by cowboy investing techniques or bad judgement of fund managers will be notional, but when the market is on a downtrend, it can punch a hole in your investment portfolio. The signs are there for anybody to see.