Rate Cuts, Expert Speak, and Investment Advice

Last week, the Reserve Bank of India (RBI) in its bi-monthly monetary policy review kept the benchmark repo rate unchanged. The move surprised markets which were expecting a rate cut of at least 25 basis points. The consensus was that liquidity in the banking system would improve thanks to demonetisation. This coupled with benign inflation would give RBI leeway to cut rates. 

In the weeks leading up to the monetary policy review, investment experts in media were urging investors to capitalize on the foretold rate cut. Their advice was unambiguous: invest in long-term bond and gilt mutual funds to make the most of the opportunity.

However, RBI’s decision to leave policy rates unchanged meant that bond yields rose sharply. The performance of mutual funds positioned on the longer end of the yield curve took a hit.

Interestingly, experts’ narrative changed overnight. Several experts who were espousing the cause of long-term bond and gilt funds did a volte-face; now the advice was to invest in short-term bond funds.

Let’s consider the case of an investor who relied on the aforementioned experts while investing. Swayed by the flurry of advice centred on rate cuts, he allocates a substantial portion of his portfolio to long-term bond and gilt funds. Expectedly, his portfolio suffers. Subsequently, he is told that short-term bond funds are a better bet. The investor clearly finds himself in an unenviable position.

To clarify such instances are far more common than one imagines. While this time around the event was an expected rate cut, in the past too, experts have been known to dish out advice, anticipating outcomes of events such as elections, political referendums, and union budgets.

Investors who rely on expert speak while investing have a simple rationale: an individual is being quoted in a newspaper or, making a television appearance, because he is an expert. So acting on his opinion is the right thing to do. Sounds reasonable, doesn't it?

Sadly, this line of thought isn’t correct. To understand why, one must understand what investment advice is.

To qualify as investment advice, apart from being accurate, the counsel needs to be customised for the investor. In other words, the investor’s risk appetite, investment horizon, financial goals need to be taken into account. That’s never the case with media quotes by experts, which are at best generic opinions.

Furthermore, often investors are prodded to invest tactically. For instance, in this case, for the ‘advice’ to play out successfully, an event—rate cut—had to occur. Investment strategies whose success hinges on an event such as election results, change in government policy, quarterly results of a company tend to be riskier than those which bank on fundamental reasons such as a macroeconomic turnaround, a company’s robust business model. Simply put, tactical investing is apt for a risk-taking investor.

Another integral aspect is the allocation made. Ideally, a tactical investment should be an ancillary holding (as opposed to a core holding) in the portfolio.

However, such nuances are never (and perhaps cannot be) communicated in a published article or a television appearance.

Hence it is important for investors to appreciate that there is a fundamental difference between investment advice and expert speak in the media.

Investors who need assistance would do well to source the same from a competent and independent adviser. While expert speak in the media can be a source for information, treating it as investment advice can result in unsuitable investments, and failure to meet financial goals.

Do Fund Companies Dislike Direct Plans?

Recently, I had a rather curious interaction with a fund company. Promoted by a public sector bank, the fund company ranks among the larger ones in the industry.

I invested in an equity fund opting for Direct Plan; as per norm, the payee on the cheque was: XXXX Fund – Direct Plan – Growth; the same was explicitly mentioned on the transaction slip as well. Oddly, the statement of account revealed that I had been allotted units under the Regular Plan.

Assuming that it was a clerical error, I wrote an email to the fund company explaining the facts of the case. To my surprise, they wrote back saying “With regards to your query, we would like to inform you that a broker code (ARN Code) was mentioned in the application submitted by you, hence we allotted the units in regular plan. We request you to kindly contact with the respective branch for further assistance.”

I haven’t engaged a distributor for several years now. Furthermore, even if that were the case, the fund’s Scheme Information Document (SID) states that in cases where a broker’s code is mentioned and the plan mentioned is ‘Direct’, the default plan is deemed to be ‘Direct’.

In effect, the fund company had violated its stated guidelines.

After a significant back and forth over email and several tele-conversations, the fund company grudgingly agreed to modify the plan from ‘Regular’ to ‘Direct’.

This episode got me thinking about why my investment had been earmarked under the Regular Plan instead of the Direct Plan. As was evident from the email, it wasn’t an oversight. Rather, the fund company staff was following laid down procedure. Simply put, they had been instructed to act in a manner that was in contradiction to what the SID stated.

But why would a fund company indulge in such skulduggery?

It is common knowledge that despite Direct Plans having been in existence for nearly four years now, a bulk of mutual fund assets continue to be garnered by distributors under Regular Plans.

Moreover, Direct Plans have a lower expense ratio as compared to Regular Plans since distribution expenses et al are excluded. Also, no commission is paid to distributors under the Direct Plan.

In other words, assets under Direct Plans can’t be utilised to compensate distributors. Sadly for some fund companies, that’s unacceptable because in their books, distributors are more important than investors.

Don’t get me wrong. I’m not making this out to be a 'distributor versus investor' debate. However, the fund company has done so, by creating a mechanism to surreptitiously transfer investments from Direct Plans to Regular Plans.

Distributors have an unquestionable role to play in the mutual fund industry. Fund companies are entitled to utilise their services and compensate them as deemed fit. However in their zest to provide for distributors, investors’ interests shouldn’t be compromised.

Investors on their part must evaluate a fund company’s pedigree while making investment decisions. Fund companies that fail to watch out for investors should be steered clear of.

Of Demonetisation, My Cousin ‘P’, and a Polarized Population

As I write this blog post, television channels continue to beam images of long queues outside banks and ATMs, interspersed with bytes from harassed citizens. Clearly, the surprise announcement demonetising bank notes of INR 500 and INR 1,000 has caught several on the wrong foot, and disrupted day-to-day life.

But while the focus is on disruption, there’s an interesting undercurrent that many have overlooked.

A day after the announcement, I met my cousin whom we shall refer to as ‘P’ (the secrecy is for obvious reasons; I don’t want to be ostracized by my family :)). ‘P’ was livid to put it mildly; he said: “I voted for Modi and yet he has ruined my business”.

My cousin makes a living as a trader in the auto spare parts industry. He conducts a significant portion of his business transactions in cash, and by and large stays outside the tax purview. Now he is apparently engaged in ‘creative’ consultations with his accountant, which include documenting back-dated sales transactions and paying taxes as well.

To be fair to ‘P’, he is a small fry in the larger scheme of things, a minion compared to the big fishes whose sizeable unaccounted cash was the target of the demonetisation drive. However, both ‘P’ and the big fishes represent that section of the population, which firmly believes that they are justified in not paying taxes. To clarify, I’m referring to wilful disregard of law, not ignorance of it.   

On the other side of the spectrum is the ‘cheque and TDS’ brigade of the population. Salaried individuals, for instance, who have over the years accounted for all their earnings, and paid taxes. The ‘cheque and TDS’ brigade, while suffering through long queues and a liquidity crunch, is nonetheless gleefully smiling at the woes of the ‘why should we pay tax?' brigade. Oddly, in the midst of disruption, they’ve found vindication—for paying taxes, filing returns, not possessing unaccounted wealth— for being law-abiding citizens.

The polarization is perceptible everywhere from the streets to discussion boards. On a lighter note, the last time the Indian population was so polarized, was in 2013, when the man who announced demonetization—Prime Minister Modi—was named as the BJP’s prime ministerial candidate for the 2014 Lok Sabha election, and that worked out well for him.

Back to serious stuff. Several sections of the media are carrying reports on the flipside of demonetisation. Predictions range from a short-term disruption in economic growth, to the upside of a good monsoon being wiped off, to a structural damage to the economy and a prolonged bear phase in markets. To my mind, these are educated guesses at best, because we are in unchartered territory. How the demonetisation gambit plays out over the long-haul is anyone’s guess.  

However, what we can be certain about is how the aforementioned segments of the Indian population will act going forward.

First, the ‘cheque and TDS’ brigade. Make no mistake, this brigade will go from strength to strength. Existing members will continue to walk the line; also, its ranks will swell, thanks to new recruits who will see the upside of being on the right side of the law.

Then there’s the ‘why should we pay tax?’ brigade. Sadly, it will be naïve to believe that one brush with the law will instantly reform every unscrupulous individual. But what will change is the way they operate.

Existing systems which help them evade taxes and get away with it, will be disbanded. Instead, they will be forced to manufacture alternative ways and means to continue their corrupt practices. More importantly, thanks to the precedent of demonetisation, such individuals will be forced to constantly look over their shoulder. One can hope that over time, the combination of fear along with more anti-corruption regulations will deliver the desired results. 

As previously mentioned, how demonetisation plays out over the long-haul is anyone’s guess. But if shivering spines of several tax evaders are an indication, demonetisation deserves at least a thumbs up.

Mr. Portfolio Manager: It’s About Conviction, Not Guarantees

Over the years, in my several interactions with portfolio managers most have claimed to be big investors in funds they run. Perhaps it was politically correct to do so. Then again, there was no way to independently verify their claims. However, with market regulator SEBI mandating that investments made by managers and the fund company's top brass be disclosed, the scenario has changed.

The disclosures have been startling to say the least. Several long-tenured managers running large diversified funds have nominal investments to show for, while others have chosen not invest in their funds. It can be safely stated that the principle of having ‘skin in the game’ hasn’t been embraced by many managers.

Recently, a manager who has no investments in his funds came up with a novel justification. He stated that a ‘manager investing in his own fund doesn’t guarantee performance’; hence, his investments (or lack of them) are immaterial. To clarify, he isn’t the only manager to have taken that stand. In my opinion, this line of thought is both naive and flawed.

Given their market-linked nature, mutual fund investing entails taking on risk. While the degree of risk may vary depending on the kind of fund chosen, risk is pervasive nonetheless.

So how do investors mitigate risk? By performing an evaluation. For instance, some may focus on quantitative parameters such as past performance, risk-return showing, while others emphasize on qualitative factors—manager skill, investment process et al. It isn’t uncommon for investors to combine the two either.

The portfolio manager’s investments in funds he runs is yet another evaluation tool. A manager investing substantial monies in his funds demonstrates conviction in his investment approach and acumen. It’s a classic example of putting one’s money where the mouth is.

None of the evaluation parameters can guarantee performance. But that in no way diminishes their relevance. Of all people, a portfolio manager should be aware that there are no guarantees in his domain. Investing in markets akin to a business of risk, not a business of guarantees. Does the fact that there is no guarantee of returns, prevent the manager from exhorting investors to invest in funds he runs?

I have no doubt that some managers will continue to steer clear of investing in funds they run. But they would do well not to trivialise the importance of having ‘skin in the game’ using inane arguments. As for investors, I am certain that like me, most will be wary of the chef who doesn’t eat his own cooking.

Investment Lessons from ‘The Godfather’

For film buffs and critics alike, ‘The Godfather’ embodies what celluloid magic is all about. Over four decades after its release, the movie continues to capture the imagination of audiences like no other, reaffirming its status as a classic.

But there's a lesser-known aspect of 'The Godfather'. Apart from being a source of inspiration to aspiring actors and filmmakers, the film has a lot to offer to investors as well. Following are investment lessons from ‘The Godfather’:

Barzini is dead. So is Phillip Tattaglia, Moe Greene, Stracci, Cuneo. Today I settled all family business

A laser-like focus on objectives and ruthless discipline in their pursuit, are defining traits of Michael Corleone’s personality. Be it protecting his family or safeguarding his business interests, Michael is decidedly aware of his goals and will do whatever it takes—sacrifice his career in the armed forces, join the ‘family business’ and even eliminate his rivals—to achieve his goals.

Similarly, investors would do well to set goals before they start investing. Goals can range from near-term ones such as creating a holiday budget, to long-term goals like a retirement kitty. Apart from making investing focussed, setting goals also helps in tracking progress. Thereby deviations (if any) can be easily rectified. Furthermore, being disciplined (read: curtailing wasteful expenditure, and investing regularly in line with a plan) will help investors stay on course to achieve their goals.

Some people will pay a lot of money for that information; but then your daughter would lose a father, instead of gaining a husband

Michael, a fugitive on the run in Sicily, is enamoured by a local girl. When confronted by her indignant father, Michael calmly reveals his true identity. Also, he lays out the options available, and the trade-off therein.

Likewise, while investing in market-linked instruments, investors must be unambiguously aware of the risk-return trade-off. For instance, a small-cap stock can deliver substantially higher return versus a large-cap stock; however, the potential upside comes at a price—higher risk, if the investment doesn’t play out as expected. Similarly, sector-focused mutual funds can outperform diversified funds, but they expose investors to higher risk. Hence investors must accurately understand the risk-return trade-off before making an investment decision.

Where does it say that you can't kill a cop?

When the Corleone family is under attack, Michael comes up with a seemingly outlandish plan that includes killing a corrupt police officer. His sound rationale wins over his sceptical associates. Essentially, Michaels’s willingness to think out-of-the-box wins the day.

At times, investors can be guilty of being orthodox in their choice of investment avenues. For example, some invest only in bank fixed deposits and small savings schemes because of habit rather than choice. By refusing to consider other apt options, investors run the risk of not meeting their investment goals.

For instance, an investor in his twenties who is saving for retirement 30 years hence, shouldn’t hold a portfolio comprised of only fixed deposits and bonds. Equities and mutual funds must find place therein. Remember, risk in itself isn't bad; rather, investing without being aware of it, and/or failing to correctly assess it, gives rise to thorny situations.

It's not personal. It's strictly business

Every character quoting this legendary line tries to convey that a given action should be seen as a business decision i.e. in a dispassionate manner. In other words, it has nothing to do with personal feelings. The 'not personal' part holds good for investments as well.

At times, investors get 'attached' to their investments. This is especially true of stocks and mutual funds that have had a successful run. The trouble starts when the investment avenue is no longer equipped to perform as it has in the past. Then there are misguided investments which fail to deliver, but investors hold onto them, hoping to ‘get even’.

This approach to investing is unwarranted. An investment is simply a means to an end i.e. the investment objective. If a thorough evaluation suggests that the investment is no longer equipped to play the part that it was supposed to, investors must salvage the situation by exiting the investment at an opportune price and time.

Tom Hagen is no longer consiglieri 

While expanding his operations, Michael sacks his adoptive brother/long-time associate, Tom Hagen from the post of consiglieri (adviser). Stating that Tom isn’t a wartime consiglieri, Michael replaces him with someone adept at strong-arm tactics, since the situation demands it.

Barring a small section of investors who can manage their own investments, others need assistance in the form of investment advice. Investors have a variety of options—distributors, advisers, robo-advisory firms—to choose from. Quality of investment advice can and does have a bearing on investment results. Hence, investors must perform rigorous due-diligence before engaging an adviser. Also, there is a case for reviewing the adviser’s performance at regular time intervals.

I'll make him an offer he can't refuse

In Godfather parlance, this iconic line represents a veiled threat. Refusal to comply with the offer can lead to dire consequences.

In the world of investments, there are periods when markets are frothy and irrational exuberance is the order of the day. In such periods, it is not uncommon for investors to encounter investment propositions that claim to offer a win-win proposition. For instance, an investment that offers high return with virtually no downside. That’s when investors must remember that if the 'offer' sounds too good to be true, then it probably is.

Should Investors Tap Into Media For Investment Advice?

Last weekend at a party, I met a rather interesting individual who declared that ‘the best things in life are free’. To buttress his view, he spoke about investments, and questioned the need to engage an adviser (read pay a fee), when one can get free advice from the media i.e. publications and television channels. I’m unaware as to what drove his belief: experience or the lure of ‘free’. In any case, his views found several takers, and soon he was dishing out ‘free advice’ on the best sources of investment advice. 

To be honest, this isn’t the first time I have heard such views being expressed. Many investors are convinced that sourcing and acting on investment advice from media can be financially rewarding. But is that line of thinking prudent? Let’s find out.

Advice vs. Coverage

Any adviser worth his salt will agree that investment advice should be focused on the investor i.e. customised to his risk appetite, investment horizon and goals. The key is to navigate the investor’s portfolio through various events, and stay on course to achieve predetermined goals.

Conversely, the media typically focuses on current events and trends. The journalist/host will have a perspective in place. Domain experts contribute to the perspective with quotes and/or data. Having covered one event, the media moves on to the next.

Whether or not the coverage is apt for every investor following it, is anyone’s guess. Therein lies the fundamental difference between investment advice and media coverage.

Go Where the Wind Blows

In Feb 2016, when domestic equity markets crashed, stocks of public sector banks were among the worst hit, reeling under burgeoning bad loans. Expectedly the media coverage was negative, and most experts opined that the worst was far from over.

Between then and now, both bank stocks and equity markets have staged a smart recovery. While fundamentally not much has changed, appreciating stock prices have resulted in sections of the media putting a positive spin on PSU bank stocks with experts stating “You can’t do away with SBI. If it’s not in our portfolio, we are missing out on India’s economic growth…” and so on. To clarify, such instances of rapidly changing positions are common in media.

Is this a case of mala fide intent? Not at all. This is simply the nature of the beast; media covers events in a manner that will appeal to its audience. Investors choosing to treat media coverage as investment advice, and acting on the same, only have themselves to blame.

Should We Shoot The Messenger?

Does the solution lie in insulating oneself from media? I don’t think so. Media can be an excellent source of information and updates. Following reputed channels and publications can help stay abreast of events. That’s where investors must draw the line.

I’m not suggesting that every investor must engage an adviser. There are several who are conversant with the nuances of investing, and don’t need to engage an expert.

As for investors who need assistance, but have never paid for investment advice, admittedly it can be a difficult threshold to cross. But there’s a need to weigh up the downside of a misguided investment versus the cost of acquiring prudent and expert investment advice. 

In any case, relying on media for investment advice seems like an imprudent choice.

Will This Be Robo Advisory Firms’ Achilles' Heel?

Robo advice has become a buzzword in the financial services domain, and robo advisory firms are mushrooming at a furious pace in India. A combination of factors—growing financial literacy among investors (especially in urban areas), internet penetration, and enhanced awareness about mutual funds, among others—has contributed to this phenomenon. It can be safely stated that robo advice is an idea whose time has come.

As the name suggests, robo advice eliminates human intervention. Instead of an adviser, the investor is guided by algorithms run on a website. Typically, the investor feeds in information about his age, risk-taking ability, income and expenses, current assets and liabilities, financial goals, expected inflation et al. The robo adviser uses the data to produce a suggested asset-allocation and a list of mutual funds that can aid the investor achieve his financial goals while adhering to his risk appetite. Furthermore, robo advisory firms also enable investors to make online mutual fund investments thereby acting as distributors too.

To my mind, several of the robo advisory firms do a decent enough job when it comes to risk-profiling and arithmetic calculations. Likewise, it is evident that some have paid due attention to areas such as user interface. It is the last mile—recommending mutual funds—where most err.

It is commonplace to see funds being recommended based solely on performance. Typically, the three-year period is considered, and top-performing funds make it to the robo adviser's list. Recommendations are also offered in the form of a portfolio of mutual funds. Yet again, the three-year showing is the primary factor for picking funds from various categories. Given the strong showing posted by small/mid-caps in the recent past, it comes as no surprise that at present several recommended portfolios have a strong small/mid-cap bias.

A rule of thumb approach is perceptible in the recommendations. For instance, investors with a moderate risk appetite are offered large-cap funds. However, no thought is applied to the nature of the fund. For instance, a large-cap fund wherein the manager aggressively churns the portfolio, and draws on factors such as news flow, market sentiment and momentum while investing might not be suited for a moderate risk-taker. Yet such funds make the cut thanks to their performance and large-cap classification.

Not only is making recommendations based solely on performance a fundamentally flawed approach, it also reveals a poor understanding of the basics of investing. When the present top-performers are replaced by others (as it can and does happen in the case of market-linked investments) will investors be expected to churn their portfolios? Robo advisory firms can’t take refuge under the premise that their advice is bound to be ‘formulaic’. There is a difference between formulaic advice and flawed advice.

Don’t get me wrong. I’m not questioning the utility of robo advice. For first-time investors and those with uncomplicated investment needs, robo advice can be the way to go. But robo advisory firms must realise that there is more to investment advice than just running calculations. Indeed, flawed advice can significantly hurt investors' interests.

Robo advisory firms have a huge opportunity at hand. If tapped well, robo advice can prove to be a game-changer for both the mutual fund and distribution industries. However ignoring the ‘advice’ aspect of the business will prove to be a costly miss.

What Executive Remuneration Disclosures Reveal About Fund Companies

In March 2016, SEBI issued a circular mandating that the remuneration of every fund company’s top brass be disclosed. Apart from the remuneration of the CEO, CIO and COO, the circular requires that fund companies publish a list of employees whose annual remuneration is equal to or above INR 6 million, and also the ratio of CEO's remuneration to median remuneration of employees.

Some fund companies have recently released the requisite information on their websites. In an earlier post, I had expressed reservations regarding the utility of these disclosures. Interestingly, the manner in which disclosures have been made, has unintentionally revealed more than the disclosures themselves.

To begin with, despite the deadline not all fund companies have made the relevant disclosures at the time this post was written. Perhaps SEBI-mandated disclosures aren’t important for some fund companies.

At their core, the said disclosures are intended at empowering investors. Hence it would be reasonable to assume that investors should be able to easily access them. Is that the case? Let’s find out.

Of the top 10 fund companies (which account for roughly 80% of industry assets; read substantial investor interest), four—Birla Sun Life Mutual Fund, SBI Mutual Fund, UTI Mutual Fund and Franklin Templeton Mutual Fund—haven’t disclosed executive remuneration as yet.

A common thread running through the balance six fund companies is that only existing investors can access the information. In other words, a prospective investor who may want to use the information to make an investment decision is unable to do so.

Furthermore, before accessing the information, investors are required to agree to a long list of terms and conditions which among others, state that the information shall not be shared with anyone in any form or manner. In other words, the disclosures are confidential in nature; oxymoron anyone?

Now let’s delve into how fund companies fare in terms of accessibility of disclosures. Of the top 10, HDFC Mutual Fund fares well. Investors can access the requisite information after entering two data points and a CAPTCHA. All the information is available on a single web page, and can be easily copied into other user-friendly formats.

Accessing data on Reliance Mutual Fund’s website is trickier. It helps to have a registered mobile number which can be used to generate a One Time Password. Alternatively, a combination of two or more data points are required. While the information is available in a single web page view, it cannot be copied into another format.

ICICI Prudential Mutual Fund fares worse offering access to only one executive’s remuneration at a time. In other words, one needs to tediously move back and forth to access multiple data points.

While accessing information from IDFC Mutual Fund requires two data points and a CAPTCHA, Kotak Mutual Fund demands six data points.

DSP BlackRock Mutual Fund holds the dubious distinction for being most secretive while disclosing executive remuneration. Data entered on the website leads to an auto-generated mail being triggered to the investor’s registered email-id. Clicking on a link therein takes the user to a webpage wherein the investor can request for one executive’s remuneration at a time. Following this a message flashes “Your request for information has been registered. Our Human Resources team will reply to you shortly”. I am yet to receive any information despite passage of over 24 hours.

However not all fund companies fail to pass muster. Two of the smallest fund companies—Quantum Mutual Fund and PPFAS Mutual Fund—have followed the disclosure norm in letter and spirit. Not only is executive remuneration-related information freely available on their websites (in other words, one need not be an investor to access the information), the information can be conveniently accessed in the PDF format. 

It’s quite likely that in the days to come, SEBI may issue guidelines standardising the manner in which executive information must be disclosed. However at present, when fund companies are using their discretion to disclose information, speaks volumes about their attitude towards investors.

Direct Plans: Much Ado About Nothing

Admittedly, when I first heard someone complain about direct plans, I was surprised. But over time, the negative buzz has only grown. A few months ago, I met some individuals who are engaged in mutual fund distribution. Their grouse was that introduction of direct plans has resulted in a significant loss of business for smaller distributors like them. They were convinced that it was only a matter of time before all mutual fund investors migrated from regular plans (wherein the expense ratio includes distribution expenses, commission et al) to direct plans.

Then there were investors who were unhappy with their investments in direct plans. They maintained that direct plans were responsible for their woes. Things came to a head last month when SEBI issued a circular mandating that fund houses disclose information regarding commission paid to distributors, among others. Some concluded that this was a sly move to promote direct plans at the cost of regular plans.

In all the aforementioned cases, direct plans were painted as villains of the piece. But do those arguments hold weight?

       

Let’s consider the first grouse: direct plans have resulted in small distributors substantially losing their business. As per data released by AMFI, as of Feb 2016, “39% of the assets of the mutual fund industry came directly. A large portion of direct investments were in non-equity oriented schemes where institutional investors dominate”.

It is common knowledge that most institutional investors were (and continue to be) serviced by large distributors i.e. distribution arms of banks, broking firms and distributors with a nationwide presence. So it can be safely stated that institutional monies flowing from distributor mode to direct mode hasn’t had a significant impact on small distributors.

Now let’s focus on retail investments i.e. the universe largely catered to by small distributors. AMFI data reveals that of the total industry assets (INR 13.5 trillion), roughly 44% were held by individual investors; of these just 13% were invested in direct plans.

It is noteworthy that direct plans with a lower expense ratio have been on offer since Jan 2013. In other words, even after more than 36 months, a bulk (87%) of retail assets continue to be invested via distributors. The much-feared and speculated exodus of retail assets from distributor to direct mode hasn’t taken place.

The second grouse—investors expressing dissatisfaction with direct investments—has its roots in a half-baked understanding of how direct plans should be utilised. After they were introduced, benefits of direct plans (lower cost versus regular plans, and thereby higher performance potential) were universally extolled. Expectedly, some investors decided to invest independently, and chose direct plans over regular plans. However while doing so, several overlooked an important caveat: direct plans are meant for informed investors who can make investment decisions independently.

Not all investors who severed ties with their distributors were capable of investing prudently. To further complicate matters, their chosen alternative for the distributor—experts in media—left a lot to be desired. Experts offering generic opinions on investing in the media doesn’t necessarily qualify as investment advice.

A distributor offering advice based on the investor’s risk profile, investment objectives and horizon cannot be substituted by a media talking head. The need for robust investment advice was accentuated in the last 18 months or so, when markets were at their volatile best. Sadly, some investors have erroneously chosen to blame direct plans for their woes.

The merits of direct plans are indisputable. Indeed, their introduction has gone a long way in democratizing mutual fund investing. 

For investors who need investment advice and services, engaging a distributor and investing in regular plans is a viable option. Conversely informed investors can utilise direct plans and benefit from lower costs. The onus of making the apt choice lies with investors.

Why Investors Must Cheer SEBI’s Initiative On Mutual Fund Disclosures

Last week, market regulator SEBI released a circular that among others, enhances mutual fund disclosures. The new directives have the potential to be game changers.

Let’s start off with the disclosure that has garnered most attention—commission paid to distributors. SEBI has ruled that henceforth half-yearly account statements sent to investors will have information regarding commission paid to distributors. Commission has been defined to include both monetary and non-monetary payments made by the fund company to the distributor. Furthermore, the statement will also have information regarding expense ratios (for both regular and direct plans).   

Some quarters are up in arms against this ruling. While some feel that disclosing commission-related information will push investors towards direct plans, others argue that this is a conspiracy to ease out small distributors. I believe the reservations are a case of stretching the point.

Fund companies pay commissions to distributors for selling their products (and rightly so!); all they need to do is disclose the same to investors (who bear the cost). No one’s suggesting that fund companies must stop compensating distributors. Also, to assume that an investor who is satisfied with his distributor’s service, will turn his back on the same and opt for a direct plan, because the commission is disclosed is a fallacious argument. So long as the distributor adds value, the investor will continue to be associated with him.

In the confusion, most have overlooked what to my mind is the most important ruling—investments in funds by portfolio managers and other personnel. From May 2016, every fund’s Scheme Information Document (SID) will have information related to investments made by the fund’s portfolio manager(s), the AMC’s Board of Directors and other key managerial personnel.

The rationale behind this move is to encourage the concept of ‘skin in the game’. The concept is far more common in the West, than in India. For instance since 2005, the U.S. Securities and Exchange Commission has required fund companies to annually disclose how much portfolio managers invested in the funds they run. At its core, 'skin in the game' is about inspiring confidence in investors. Managers who invest alongside their investors show conviction in their investment approach and acumen. It’s a classic example of putting one’s money where the mouth is. This regulation offers investors insights into funds, and the opportunity to evaluate them in a manner hitherto unavailable.

Then there’s the directive on soft-dollar arrangements. So far, investors have been blissfully unaware of soft-dollar arrangements between fund companies and brokers, and how the same impacted their investments. SEBI has decided that henceforth, soft-dollar arrangements will be limited to benefits that are in the interest of investors, and the same shall be disclosed.

Admittedly, some rules seem odd—it has been mandated that compensation of the fund company’s top brass be disclosed. Likewise, fund companies will have to publish a list of employees whose annual remuneration is equal to above INR 6 million, and also the ratio of CEO's remuneration to median remuneration of employees. I fail to see how these provisions can help investors make better investment decisions. Investors’ interests would have been better served if the method of computing annual remuneration had been disclosed. That way, investors could have comprehended what fund company top bosses are mainly compensated for—growing assets or fund performance.

That said, all in all, the mandated disclosures have the potential to usher in an era of transparency in the mutual fund industry. However, one must understand that a disclosure (read transparency) isn’t an end in itself. Learning more about funds should translate into informed investment decisions, and in turn, goals being achieved. The onus to make the most of the information on hand, lies on investors, advisers and distributors alike.

Stupid Portfolio Manager vs. Ignorant Portfolio Manager

Aggression seems to be the flavour of the season. Several politicians routinely breathe fire; at present, students at a New Delhi campus are in a belligerent mood. No discussion on Indian cricket is complete without the mention of aggression; likewise, a bespectacled newscaster known for his confrontational demeanour tops the TRP charts. And just when one thought it couldn’t get any more interesting, aggression has reached the mutual fund industry.

Recently, the promoter of an asset management company published a piece insinuating that competing portfolio managers are stupid. His contention is that since the NDA government assumed charge at the centre, bogus/hyped earnings estimates have been doing the rounds. Hence, equity portfolio managers who believed in and acted on the same are stupid. Furthermore, portfolio managers who didn’t fall for the hype, but failed to communicate their misgivings (on lucrativeness of equities) to investors are dishonest.

Apart from a touch of arrogance, the piece also reveals a poor grasp of how investing works. Investing is a personalised activity i.e. each investor pursues an investment philosophy and strategy that works for him. This principle holds good for portfolio managers as well.

For instance, while some managers pay more attention to top-down factors, others rely on bottom-up analysis. Some invest with a growth-bias, while others have a value-bias. There are managers plying research-oriented strategies and others who deploy a sentiment and momentum-driven approach. Even the investment horizon can vary significantly. Admittedly some strategies are more efficient than others, but that doesn’t take away from the fact that investing isn’t a one-size-fits-all activity, as the article erroneously suggests.

Equity investing isn’t a pure science. When a manager evaluates a business, factors such as his investment philosophy, interpretation and biases (among others) come into play. To suggest that every manager should have (or did) read the macroeconomic environment in a uniform manner is oversimplification. More importantly, is it apt to evaluate managers based on one event? Prudence demands that an equity manager be evaluated over the long-haul spanning a market cycle.

An element of bragging rights is perceptible too. Over the last year or so, equity markets have experienced a fair bit of volatility. The flagship equity fund (from the author’s AMC) takes cash calls based on valuations, and has expectedly fared well in a peer-relative sense. The portfolio manager and strategy deserve credit for the showing. However, that doesn’t diminish the credibility of competing managers who don’t take cash calls; expectedly, such funds have fared poorly in the recent past.

   

On the dishonesty bit, yet again the author displays his ignorance by mixing up the roles of an adviser and a portfolio manager. The latter is responsible for running the fund to the best of his abilities and in the investor’s interest at all times. However, offering the investor asset allocation-related advice, or managing the investor’s portfolio is not the manager’s role. That’s what advisers are engaged for.

In the competitive asset management industry, the need to celebrate and spread the word about one’s success is understandable. However, branding the competition as stupid and dishonest on untenable grounds reeks of ignorance.

Why Indian Fund Companies Shouldn’t Fear Greater Transparency

Media reports suggest that several Indian fund companies are at loggerheads with market regulator SEBI. The latter wants to increase transparency by disclosing commissions paid to distributors in investors’ statements of accounts. On the other hand, fund companies believe that doing so will be detrimental to their interests. According to reports, industry body AMFI has communicated its reservations to the regulator.

Reasons for opposing the move are varied: some fund companies think disclosing commission-related information will dissuade investors. Others feel that bombarding investors with too much information will be detrimental. 

To my mind, the concerns raised by fund companies are both misplaced and weak. To begin with, the proposal doesn’t alter the working of the fund industry in any manner. Fund companies pay commissions to distributors for selling their products (and rightly so!); all they need to do is disclose the same to investors (who bear the cost). No one’s suggesting that fund companies should stop compensating distributors.

As for fears of investors becoming upset by learning about commission payments, or becoming confused on account of too much information—those are weak arguments. Fund companies would do well not to underestimate the investor’s intellect. To assume that an investor who is satisfied with his investment will turn his back on it, because the agent’s commission is disclosed is a fallacious argument.

When an investor invests in a mutual fund, effectively he engages a fund company to manage his monies. The fund company charges a TER (comprising everything from operational expenses, the fund company’s fees, to the distributor’s commission) for the service. An unambiguous disclosure will aid investors better understand the fund’s working, and thereby make informed investment decisions.

For instance, a fund company which keeps costs (including fees and commissions) low and thereby enhances the fund's returns can benefit by communicating the same to investors. It can be safely stated that such disclosures will go a long way in winning investors’ patronage.  Conversely, the investor has a right to know if his fund is losing its competitive edge on account of exorbitant commission pay-outs.

Case for more disclosures

I’m surprised that in its quest for greater transparency, SEBI didn’t start at the top of the pyramid i.e. with fund companies. There is a strong case for making public, information related to the fund company’s compensation policy for its investment staff (portfolio managers and analysts), and also information regarding a portfolio manager’s personal investments in funds he runs.

Taken together, the two can reveal a lot about the fund company’s culture, its attitude towards investors, and a manager’s commitment to his fund—all of which can be vital in helping investors make better decisions. 

Admittedly, from the perspective of fund companies, revealing information that hitherto was private can be discomforting. But it is in their interest to embrace this change. Greater transparency isn’t an end in itself. The intent is to improve investors’ investment experience, and in turn make mutual funds more appealing. And when the investor wins, so will fund companies.

Investment Lessons from Yuvraj Singh’s T20 Innings

On Sunday, I watched the third T20I between India and Australia. Chasing a stiff target of 198 runs, India seemed on course until the third wicket fell. The next batsman Yuvraj Singh, was making a comeback to the national team. In the initial part of his innings, Yuvraj struggled, scoring just five runs in nine balls. As the required run-rate rose, the buzz on social media and the views of television commentators weren’t particularly charitable.

Then something interesting happened with India needing 17 runs to win in the last over. 11 runs were scored from the first three deliveries which Yuvraj faced – including a four and a six – putting the run chase back on track. With India winning the match, Yuvraj was hailed as a 'hero' all over.   

To my mind, the reaction was a classic case of circular logic; in other words, the result was used to selectively determine the cause. I have no doubt that had India lost, the focus would have been on the first half of Yuvraj’s inning wherein he struggled; furthermore, he would have been painted as the villain of the piece. However a win meant that the focus shifted to his impressive performance in the last over.  

Now let’s draw a parallel with the world of investments. Investors often rely solely on the performance to draw an inference about an investment avenue’s worthiness. For instance, if a mutual fund clocks a strong showing, investors infer that the portfolio manager must be skilled, the investment process must be robust, and so on. However such ‘analysis’ is fundamentally flawed. 

To begin with, in a rational approach, one or more causes lead to a given result, and not vice versa. Also, the performance-based approach fails to separate luck from skill. Consider, a mediocre fund helmed by an incompetent portfolio manager who got lucky with his stock picks. On account of the positive performance, the manager will be considered to be skilled. Likewise, a skilled manager whose investment style is currently out of favour will be given the thumbs-down on account of a poor showing. Investors’ woes will be further worsened if they choose to focus on near-term performance in an asset class like equity. 

A prudent approach would be to identify and evaluate factors that will influence performance. The results of this evaluation must then be compared with the fund’s long-term performance. If the two are in sync, then the analysis can be considered to be accurate.

Market-linked investing is inherently risky. Investors who base their decisions on performance, further accentuate the risk borne. While adopting this approach in cricket-related matters is harmless, doing so while investing could be a recipe for undesirable results.

Of Mutual Funds, Asset Sizes and Oblivious Experts

With calendar year 2015 coming to an end, business dailies are busy publishing round-ups of the year gone by. Expectedly, performances clocked by various investment avenues have been put under the scanner. An article detailing the performance of the largest (by asset size) equity mutual funds caught my eye. In a year when equity markets have had a rough run, most of the abovementioned funds fared better than their respective benchmark indices.    

However the truly interesting bit was an expert’s take on the performance. He attributed the positive showing to a combination of active fund management and strong flows into funds. The former makes sense. In a year when large-cap stocks struggled (the S&P BSE 100 posted a loss of 3%) and small/mid-caps fared somewhat better (S&P BSE MidCap: up 6%, and S&P BSE SmallCap: up 5%), a benchmark-hugging strategy wasn’t going to work. Skilled stock-picking and portfolio management were the need of the hour.

Robust inflows aid performance?

Now for the latter part: strong inflows in equity funds aiding performance. Not only is this reasoning questionable, it also exhibits a poor understanding of how mutual funds work.

Let’s take an example: Both Rs 100 and Rs 1,000 invested in a stock that appreciates 20% over a year deliver the same annual rate of return—20%. Simply put, a higher investment sum doesn’t alter the rate of return.

Critics might argue that the return varies i.e. while Rs 100 yields Rs 20, Rs 1,000 returns Rs 200. Fair enough. But let’s not forget that inflows (a higher investment amount) also result in a proportionately higher number of mutual fund units being issued. In other words, the higher return (Rs 200 versus Rs 20) is equalised by a larger number of units, resulting in the same rate of return.

Buying on dips: Theory vs. Practical

The expert further elucidates how robust flows helped portfolio managers invest smartly during corrections. Portfolio managers would like inflows to coincide with downturns; invest on downturns and then see those stocks outperform thereon. Admittedly in theory, that premise sounds fine. However in practice things work a bit differently. 

To begin with, typically such a phenomenon plays out over the long-term, and not over a year. Furthermore, in 2015, not many of the better performing stocks displayed a ‘V-shaped’ recovery. Any manager expecting the ‘downturn-inflows-invest-upturn’ cycle to play out consistently and immediately is banking on luck.    

On the other hand, a skilled manager focuses on portfolio construction—stock and sector allocation, managing liquidity and risk, among other aspects—which in turn enables him to rejig the portfolio and increase allocation to attractively valued stocks. Hence, yet again it doesn’t take inflows to deliver a positive showing.    

Asset size and performance

To buttress his point, the expert adds that fund asset size being a constraint for performance is a myth. Let’s examine this hypothesis. In India, the framework for expenses charged to a fund is structured to reduce cost when asset size grows. Hence, the larger a fund gets, cheaper it becomes; this is certainly positive for investors. Also for debt funds, it might help to have a larger size to enable making investments in government securities, given the standard market lot size of Rs 50 mn.    

But there is a flip side too: A large fund size can pose challenges in the form of market-impact costs, the opportunity cost of having to spread trades over longer periods and liquidity management; this is especially true in small/mid-cap funds. In India, several small/mid-cap funds have mutated into large-cap dominated funds thanks to unrestricted asset flows. It’s worth mentioning that in many cases the performance in the new avatar was a shadow of its former self.

Finally there’s the often unappreciated fact that the dynamics of running a large fund are vastly different versus those of running a smaller sized fund. Not every portfolio manager has the skills to successfully run a large fund. 

Why investors must beware

There’s a plethora of investors who are yet getting used to the idea of investing in mutual funds. Sadly, misconceptions such as invest based only on performance, focus on the one-year showing are prevalent. When oblivious experts go about preaching that a large asset size aids performance et al (in other words, ‘invest in a large sized fund’) they are doing investors a disservice. On their part, investors would do well be wary of such experts and their advice.

Data sourced from: www.bseindia.com