'Mutual fund investing is subject to market risk.' How often have you laughed at the Mickey Mouse voice that announces this at top speed at the end of every MF ad? Sadly, it’s no longer a laughing matter as thousands of investors have seen the value of their funds come down by the day in the recent past.
They invested in mutual funds simply because funds are supposed to be safer than equities, and because lay investors do not have the skills and ability to analyse and independently evaluate issues like management competence and future business environment. They also don’t have an intuitive understanding of how a stock is likely to behave. The investors get the benefit of professional expertise in the form of a fund manager, who has the wherewithal to invest the corpus created by pooling together individual investments. All this comes at a cost which is spread across the pool of investors. Any risk is also, naturally, spread across investors.
But when the markets are falling relentlessly, even this portion of risk becomes too much. It is at times like these that investors understand why all MF schemes come with the caveat: past performance is no guarantee for future returns. “Diversified equity funds are actively managed, and also need to be actively tracked by investors. You can’t be a passive tracker of fund performance,” says R. Swaminathan, vice-president and national head of mutual funds, IDBI Capital.
FALL FROM GRACEThe top five best performing funds between 2005 and 2007 have lost heavily in the past 10 months.
|Fund||1 Jan ‘05 TO 31 DEC ‘07||1 Jan TO 31 OCT ‘08|
|Magnum Multiplier Plus ‘93||61.2||-55.27|
|Magnum SFU–Contra Fund||60.6||-55.03|
|Sundaram BNP Paribas Select||56.3||-50.79|
|Figures are annualised; returns in percentage; Source: NAVIndia|
Take a look at Taurus Starshare. The equity diversified fund was giving the best returns till December 2007. Had you invested Rs 10,000 in this fund on 1 January 2005 and exited in December 2007, you’d have made a profit of Rs 35,383. If you had stayed on, hoping for more, you would have lost Rs 6,686 now.
The problem with the current economic scenario is that it’s not just equity-linked funds that are doing badly. All fund categories have fared poorly; it’s just that some have done worse than others. All that the fund managers can say in their defence is that certain funds have outperformed their benchmark indices despite putting up a poor showing.
So, yes, investing in mutual funds carries an element of risk. But how can you recognise that a fund is at risk? Take a look at its cash component. All fund objectives state upfront the buffer cash and debt holding they will maintain as part of the investment objective and asset allocation. “Sebi regulations ensure that funds do not charge a management fee on the cash component,” says Prasunjit Mukherjee, CEO, Plexus, a fund advisory. The mandatory 5-10% cash holding is to meet possible redemptions, and in the case of closed-end equity funds, it is kept to take the best advantage of the investment opportunities presented by the market. However, in recent times, funds have been holding a high cash reserve much beyond the 20% that their fund offer documents state. This is to meet the current higher levels of redemptions.
But in January this year, there was little sign of such prudence. “Funds were fully invested when the markets were at a peak, and cash holdings were at a minimum to allow managers to make good use of investment opportunities with market corrections,” says Mukherjee. For instance, JP Morgan India Equity and Sundaram BNP Paribas Equity Multiplier had minimal cash holdings in January 2008. But, by September, the figures were as high as 32.5% and 30.8%, respectively. During this period, they have returned -56.36% and -56.53%, respectively, below the Sensex loss of 51.78%.
The cash holdings of funds are to meet redemptions. These funds hold a high cash reserve, indicating lower confidence in investing.
|Fund name||Sep 2008||Jan 2008|
|UTI Long Term Adv Series II||46.82||NA|
|Reliance Diversified Power||35.89||29.02|
|JP Morgan India Equity||32.50||4|
|Sundaram BNP Paribas Equity Multiplier||30.8||6.5|
|DSPML Natural Resource and New Energy||30.15||NA|
|Figures show percentage of cash holding; Source: NAVIndia|
There are other unexpected risks that certain thematic funds face. Take the erstwhile Standard Chartered Enterprise Equity Fund (now IDFC) that was launched with great fanfare when IPOs were booming. The fund’s objective was to invest a portion of its corpus in IPOs and sell them on listing to profit from the listing-day gains. The strategy worked well when there was a boom in maiden offers. With IPOs drying up and first-day gains vanishing away, the fund’s seemingly profitable idea didn’t seem so good anymore. The closed-end scheme has earned -6% since its inception.
Some funds try to overcome such problems by moving away from their stated objectives. “It was common for a fund with a mid-cap focus to stray into the large-cap territory, or a sector fund to deviate into the broader diversified equity territory,” says Mukherjee. While this might have meant better returns, at least in the short term, it also meant that the risk profile of the fund changed, putting small investors in a spot. However, the market regulator, Sebi, has cracked the whip and this problem is no longer as acute.
A far more serious and real problem today is of M&As in the mutual funds segment. Where does this leave the investors? Four fund houses have seen a change of ownership in the past one year and the fate of some others are hanging fire. The most recent is the sale of Lotus India Mutual fund to Religare Aegon Asset Management.
Such sales lead to a change in the management, which could have an unfortunate impact on the fund if the fund manager is moved out. The fund manager is important even if he is not the only one who determines the investment style of a fund.
CHANGE OF OWNERSHIP
Fund houses are into a consolidation mode. Here are a few which have recently changed hands:
|Fund house||New owner|
|Lotus AMC||Religare MF|
|ABN Amro||Fortis (current status unclear)|
Different fund houses often have different investment philosophies and styles, and they usually like all their products to conform to these. Therefore, even if the new owners retain the existing manager(s), there’s no guarantee that the fund will continue to conform to its current investment style.
For instance, when Pioneer ITI funds were taken over by Franklin Templeton, there was a clash of styles. While the former were for aggressive ‘growth’ investors, the Templeton group’s philosophy was ‘value’ investing. Fortunately for the investors, there was not much change in the investment style of the Pioneer ITI funds even after the transition. But this continuity cannot be taken for granted in M&As.
Today, the investor needs to be more involved with the mutual fund investment. He cannot afford to be passive about the active management of a fund. If you think that your job is done once you put your money in an MF, think again. Your portfolio may contain star performers, but they may not be without their share of risks and could throw your portfolio out of gear.