It pays to be a copy cat

Investors keenly watch the monthly updates of mutual funds and jump on any stock that the funds have added to their portfolio.

V.K.Sharma | Print Edition: December 28, 2006

Why do investors do this? Primarily for three reasons. The first is that they believe in the ability of the fund managers to pick the right stocks. The second is that they want to save on the heavy management fees that the asset maangement would charge the fund. The third and the most important reason is that investors are more do-ityourself types, where they get a tremendous kick when they actually outsmart the index or their favourite fund manager.

The usual warmth is saved for the new addition that a fund does. If for instance, a fund had earlier bought Sun Pharma and is now adding more, the move will usually be ignored by the market. But if they are adding the stock for the first time to their portfolio, it might result in an instant investor follow up.

Off-beat stocks are more likely to get a warmer reception than the front line ones. And if a written-off stock like Himachal Futuristic was to be added by a fund, the public response may be enough to give the stock a three-day freeze on the upper circuit.

If the new stock added by a fund also happens to be already in the investor's portfolio, the investor is likely to buy more of that. His confidence increases in his own research as he takes pride in identifying the stock earlier than the fund manager. A stock that has never been bought earlier by any fund evokes higher response.

Not every fund or a manager evokes the same kind of a fan following though. Some, like Reliance, have a huge fan following, which is evident from the Eno-like instant froth seen at counters the moment the word is out. The response to others ranges from very warm to complete apathy.

Does this strategy actually pay? I think it does, in so far as the result of our study is concerned.

There were 179 pure equity schemes in existence on 1 April 2005. Among the funds that have the BSE 200 as their universe, we chose the top three schemes that gave the highest return in 2005-6. (see table 'Better than Best').

We looked at only the new stocks that were added during the year. The investor normally comes to know about the new additions only by the first week of the next month. For simplicity sake, it was assumed that the investors bought the stock at the end of the calendar month, in which the mutual fund bought the stock. It was further assumed that the investor would buy all the newly added stocks without discretion and hold on till the end of the financial year.

The results were quite bewildering. We found to our utter dismay that in two of the three cases, the returns were higher than the returns given by the funds.. Annualised return in the newly added stocks of Taurus was 124.76% as compared to the 90.84% return given by the scheme. Similarly, stocks of Birla Sunlife also produced 138.03% annualised return as compared to 89.54% of the scheme. In the HDFC Core and Satellite fund, the returns from new stocks was an annualised 73.43%, less than the scheme's 90.44% return but good enough to match the Sensex's 73.73% and better than the BSE 200's 62.82%, which is the benchmark for the scheme. Returns, however, can vary substantially, if the investor was to pick and choose and not invest in all the stocks.

As per extant SEBI guidelines, funds are required to disclose their portfolio in the designated format once every six months and the full portfolio every year. That brings us to the big question, why do most mutual funds let their portfolios be disclosed every month? I think the issue has more to do with industry practice. As funds vie for investor attention, monthly disclosures have been taken for granted by investors. Do these funds lose on possible asset management fee? Probably. But they more than make up for the rise in prices in the stocks they have newly added and disclosed as the public makes a beeline to buy them.

One other reason why funds do not mind disclosing their portfolio is that exchange guidelines on bulk and block deals make it mandatory for the brokers to disclose the identity of the buyer and the seller. So the public can anyway come to know. Our study showed that no more than 25% of the stock additions can be traced through this mechanism. And the returns to the investors have not altered even if they were to buy the stock on stock exchange declarations rather than waiting for the monthly reports to throw light on them.

All in all, investors tend to make money when they follow the leaders. But there is no guarantee that future profits would be made this way. While individual investors can add selective stocks based on their liking, handing over the money to the safe hands of the fund manager may be a better option. It will bring good sleep and hopefully good returns as well. (The Author is the Director & Head of Research, Anagram Securities)

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