In the recent past, debt mutual funds
have witnessed two significant events. Oddly, these seemingly unrelated events
have evoked an identical response from investors.
In the first week of February 2017, RBI’s
Monetary Policy Committee unanimously voted in favour of keeping policy rates
unchanged. It was widely anticipated that the central bank would cut rates in
keeping with the accommodative stance it has adopted over the last two-odd
years.
Debt markets reacted negatively to the
pause in rate cuts, with bond yields surging sharply.
Several portfolio managers running debt
mutual funds had increased the maturity of their portfolios, to capitalise on
the anticipated rate cut. Expectedly, their performance took a significant hit.
Last week, some debt funds from Taurus
Mutual Fund were in the news on account of their poor showing; the funds posted
losses ranging from 7% to 12% in a single day. The reason—they were invested in
debt instruments from Ballarpur Industries. A credit rating agency downgraded
the issuer’s long-term rating, on account of “delays in debt servicing by the
company”, among others. The episode brought back memories of similar instances that have occurred in recent times.
In both the aforementioned instances—RBI
keeping rates unchanged, and Taurus Mutual Fund’s credit bets—it is evident
that portfolio managers were pursuing distinct investment strategies.
In the former, managers were engaging in duration plays, while in
the latter, taking credit risk was central to the strategy.
However, both strategies came a cropper to the chagrin of investors.
Deifying the
Portfolio Manager
Since then, I have had conversations with
several investors. The most common refrain was that portfolio managers are to
blame. But the grouse wasn’t along the lines of the justifiable “portfolio
managers need to take responsibility for poor investment decisions”.
Rather it was akin to “how could the
portfolio manager make a mistake?”
On digging deeper, I learnt that their
rationale was: The portfolio manager is an investment expert. He gets paid a
sizeable compensation for running the fund. Hence he shouldn’t be making a
mistake, and as a result, exposing investors to a loss.
I was surprised to note that many
investors view the portfolio manager like a superhero who cannot err. And
therein lies a fundamentally flawed line of thought.
Selecting the
Portfolio Manager
Admittedly, the portfolio manager plays a
significant part in determining the fund’s fortune. Also, it must be stated
that portfolio managers encompassing the entire spectrum—mediocre to
supremely talented—exist in the mutual fund industry. Hence, the importance
of selecting the right portfolio manager cannot be overstated.
One would expect the manager to be
skilled, and have proven his mettle over the long haul. He must have
successfully plied his craft across a market cycle. Furthermore, he needs to
demonstrate confidence in his abilities by investing substantial monies in his funds alongside investors.
Simply put, the portfolio manager
must indisputably earn his stripes before investors can entrust him
with their monies.
Pragmatic
Expectations and Evaluation
On their part, investors must be
pragmatic while evaluating the portfolio manager. Investors would be justified
in expecting the manager to get more calls right than wrong. For instance, a
manager running an active strategy is expected to beat the benchmark index over
the long haul.
However, expecting him to never
err, or deliver a positive return consistently is
unrealistic. Even the best of managers, can and will make a poor investment
decision at some point. That is par for the course in market-linked
investing.
Idolising the manager can also hurt
investors by preventing them from making an accurate evaluation when
the manager hits a purple patch. Consider the case of a manager who
takes on unduly high risk to clock superior returns.
The Flipside of
Deification
There’s a marked difference between holding
the manager to high standards, and having unrealistic expectations.
The latter can lead to disenchantment, and investors turning their back on
mutual funds.
Sadly, investors whom I interacted with
seemed to be leaning in that direction. They have jumped to the conclusion
that since the portfolio manager cannot guarantee success, they
are better off investing on their own. For most, that isn't the right
course of action.
What Investors Must
Do
Investors would do well to understand how
portfolio managers operate, and then devise an evaluation system that works for
them. A manager who fails to retain the investor's confidence should be
penalized.
But deifying the portfolio
manager and expecting him to deliver in a like manner is neither rational, nor
in the investor's interest.
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