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.