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.