Prashant Jain Quits… An Era Ends

In my nearly twenty-year tenure as a research professional, I have witnessed a host of changes in the mutual fund industry. However, among the few constants has been the presence of Prashant Jain at HDFC Mutual Fund. Jain likely holds the record for the longest manager tenure at the helm of an Indian fund. His exit from HDFC Mutual Fund came as a surprise. 

Despite his constancy, in recent times, Jain emerged as a polarizing figure in the industry. While many believed that he was past his prime, others had steadfast faith in his abilities. And for those who came in late, it was hard to figure out what the fuss about Prashant Jain was.

His research-driven investment approach, valuation consciousness, contrarian bent, and laser-like focus on the long-term, are well-documented. However, Jain will likely be best remembered for his willingness to stick to his conviction. 

Jain was willing to endure long periods of underperformance in pursuit of his conviction. When the latter paid-off, his funds would stage spectacular comebacks. Turnarounds like the ones in 2003, 2009, and 2014, cemented his position as first among equals, in the pantheon of portfolio managers.

Then again, conviction can be a double-edged sword. Admittedly, the last few years have been difficult. From 2017 through 2020, Jain’s funds delivered an indifferent showing. Their asset sizes shrunk, and risk-profiles worsened. As the sheen wore off, expectedly both Jain and his funds were severely panned by the mutual fund ecosystem.

And just when he was all but written off, Jain staged yet another comeback of sorts in 2021. Near-term showing suggests that his funds are topping their respective categories.

But there’s more to Jain’s portfolio manager credentials. 

An integral part of researching and rating mutual funds is expressing an unambiguous opinion. Sadly, a large number of portfolio managers are less-than adept at handling unfavorable views. Jain was an exception. He was always respectful of the analyst’s right to express critical views, even if he disagreed with them.

Jain’s conviction in his investment approach also shone through his personal investments. Even when it wasn’t mandatory to invest in or disclose manager investments, Jain invested millions of his personal monies in funds he ran.

Manager meetings are essential to fund research. Unlike some of his peers, Jain never had ‘no-go’ areas for interactions. 

Oddly my last interaction with Jain was some time ago when I bumped into him at an airport. Though we hadn’t met in years, Jain was quick to exchange pleasantries. He came across as the same affable person I knew, optimistic about the future of equities as ever.

His recent struggles notwithstanding, Jain made a sterling contribution to the mutual fund industry by lending it immense credibility. His exit undeniably marks the end of an era.

Go well Prashant!

#PrashantJain, #HDFCMutualFund, #HDFC, #mutualfunds, #investing, #MutualFundsSahiHai

Do Fund Managers Invest in Credit Risk Funds?

The repayment crisis in Fixed Maturity Plans (FMPs) has yet again put the focus on credit risk investing. All-too-familiar arguments suggesting that fund managers have erred by taking credit risk (or high-yield investing) have cropped up yet again.

Does this investment strategy entail risk – yes, it does. But that doesn’t make the approach flawed. To my mind, for investors who understand the risks involved, and have the ability to take on risk, credit risk investing continues to be an apt strategy.

Expectedly, fund companies and fund managers are busily defending their investment decisions. Some of the defences are admittedly ludicrous, but that’s a discussion for another day.

I thought it will be interesting to find out if fund managers are willing to put their money, where their mouth is. In other words, are managers running funds from the Credit Risk category, investing alongside investors? As of March 2019, the SEBI defined Credit Risk Funds category had assets of over Rs 81,000 crores (Rs 810 billion).

Some disclosures are in order: In the hunt for relevant information, I have perused various documents — Scheme Information Document, Key Information Memorandum, Statement of Additional Information, and fact sheets from websites of fund companies. While some fund companies continue to disclose information as of 2018, others have released updated information.

To efficiently analyse the data, I broke down manager investments into the following ranges: None (No Investment by Fund Manager), Re 1—Rs 10 Lakhs, Rs 10 Lakhs—Rs 50 Lakhs, Rs 50 Lakhs—Rs 1 Crore, Rs 1 Crore—Rs 5 Crores, Rs 5 Crores—Rs 10 Crores, Over Rs 10 Crores. The results are interesting:

Fund Managers Don’t Eat Their Own Cooking

• A massive 63% of assets in the Credit Risk category have not attracted any investments from managers running the funds. In other words, 11 (i.e. over half) out of 20 funds in the category are run by managers who are unwilling to invest in their funds.
• Roughly 8% of assets have investments in the range of Re 1 – Rs 10 lakhs.
• The only saving grace is that one fund accounting for 9% of category assets, has manager investments in the Rs 5 crores – Rs 10 crores range.

Clearly, fund managers running Credit Risk funds do not invest alongside investors.

Defending the Indefensible

Disclosures related to manager remuneration reveal that an annual compensation of Rs 50 lakhs (Rs 5 million) is commonplace even in mid-sized fund companies. Hence, the defence that managers do not have monies to invest, doesn't hold water.

Also, most managers have been at the fund's helm for a reasonably long period of time now. Hence, they cannot take refuge under the pretext of 'early days on the fund' either.

Finally, if managers have no reservations in asking investors to invest in funds they run, then no excuse is good enough for managers to not invest in the same fund alongside investors. Let's not forget: What's good for the goose, is good for the gander.

The Counterview

Sceptics will claim that a manager investing in his fund doesn’t guarantee performance. True, but, it is an undeniably important evaluation tool, which demonstrates the manager’s conviction in his investment approach and acumen. More importantly, it speaks volumes about his commitment to the fund.

I fail to see why investors should invest in a fund that the manager isn’t entirely committed to. I am certain that like me, most are wary of the chef who doesn’t eat his own cooking.

Why SEBI’s Guidelines on Mutual Funds’ Categorization and Rationalization are Flawed

Market regulator SEBI has issued a circular defining categories for mutual fund schemes, and the number of funds permitted under each category. Consequently, fund companies will be forced to either merge or liquidate all additional schemes.

For some time now, there have been rumours that SEBI has been nudging fund companies to reduce the number of schemes on offer. By issuing a circular, SEBI has forced fund companies to act.

I have no hesitation in saying that several Indian fund companies have been poor stewards of investors’ monies. They have been guilty of recklessly launching funds (often with poor investment rationale) with the sole intent of shoring up assets.

Furthermore, I believe that SEBI acted with the best of intentions, to aid investors make informed decisions by easing the selection process.

That said, I’m afraid that SEBI’s solution is flawed because it lacks nuance, and is unlikely to result in an improved investment experience for investors.

Is fewer options necessarily better?

Clearly, the guidelines are aimed at (a) reducing number of funds and, (b) bringing uniformity among funds in each category.

So, if the new fund offer (NFO) launch spree resulted in too many funds (read choices) for investors. SEBI's solution is on the other end of the spectrum—extinguish a number of funds, thereby sharply reducing choices available to investors. I'm not convinced that the latter is necessarily in investors' best interests.

Let's take an example to better understand why limiting choices need not be a good idea.

With the exception of three categories, the guidelines state that one fund is permitted per category. Hence each fund company can have say, one Large Cap fund.

Even a cursory glance at the present large cap funds reveals that there exist funds of different hues and colours.

There are funds that take cash calls, and others which are fully invested at all times; some which adopt a buy-and-hold stance and others that churn the portfolio rapidly; funds with benchmark-agnostic and benchmark-aligned portfolios.

Many of these contrasting investment styles can be found in the same fund company. Each investment style is apt for an investor with a distinct risk profile.

However, SEBI's guidelines could result in investors not having access to funds that are apt for them.

In a move that is seemingly at odds with what the guidelines aim to achieve, categories such as Dividend Yield Fund and Value/Contra Fund have been permitted. But how does one define what constitutes a dividend yielding stock, or a value/contra pick for that matter? One can’t since, there is no universal definition.

In effect, fund companies have been handed a loophole that they can freely exploit. Such a scenario can negate SEBI’s intent to ‘standardize characteristics of each category’.

Status quo for close-ended funds

In a major gaffe, the guidelines are applicable only to open-ended funds. The close-ended funds segment, which is a hotbed of questionable funds with little differentiation, and rampant mis-selling will continue to thrive.

I won’t be surprised if we see a large number of close-ended NFOs being launched in the days to come.

Bloated asset sizes of merged funds

To my mind, not many funds will be liquidated in light of the ‘one fund per category’ rule. Liquidating funds means loss of assets, and in turn, loss of revenue for the fund company.

Instead, we will see a record number of mergers. In several cases, the merged fund will have a bloated asset size making it unwieldy. Liquidity management issues could crop up, adversely affecting the performance. 

All in all, the guidelines may have been well-intentioned, but I fear this will end up as a case of throwing out the baby with the bathwater.

Should Investors Fear Debt Funds Taking Credit Risk?

In October 2008, fixed maturity plans (FMPs) were in the news for all the wrong reasons. The financial crisis had set in, and equity markets had crashed.

Debt markets weren’t spared either: it was feared that papers issued by some real estate and broking firms, among others would default. Several debt funds, including FMPs were heavily invested in such instruments. Amidst tight liquidity, there was a run on fund companies, which in turn led to distress sales, and net asset values (NAVs) crashing. The latter fuelled more panic, and further distress sales.

Roughly nine years hence, I see a similar narrative playing out in the context of debt funds taking credit risk. Admittedly, the level of fear isn’t even remotely comparable as yet, but make no mistake, the narrative is similar.

Every time a credit rating agency downgrades the rating on an instrument, it makes headlines. Media lists which mutual fund portfolios hold the downgraded paper, alongside the allocation. Words such as default and loss are liberally tossed around, leading to fund investors hitting the panic button.

So should investors fear debt funds that take credit risk? Let’s find out.

The strategy of taking credit risk (or high-yield investing) entails investing in securities with a lower credit rating. Such instruments offer a higher coupon rate (versus securities with a higher credit rating). Furthermore, there is a possibility of the price appreciating if the credit rating is upgraded.

Does this investment strategy involve risk—indeed, it does. There is risk of the issuer defaulting on the payment of interest and/or the principal. Often such bonds can be illiquid which further accentuates their risk profile.

Given the risk, should investors shun funds using a credit risk-based strategy? No, and here’s why: The strategy of taking credit risk is as legitimate as any other. Several portfolio managers (both in India and globally) have plied it successfully and delivered pleasing long-term results. A strategy doesn’t become faulty simply because it entails risk.

Some experts argue that investors should only invest in debt funds deploying the duration strategy. That’s a weak argument because failing to read the direction in which interest rates will move, can also lead to losses. A case in point is the performance of debt funds in February 2017, when contrary to expectations, RBI kept policy rates unchanged.

Also, this is a case example of missing the woods for the trees—mutual fund investing is not without risk. Sure, some strategies are riskier than others, but risk is omnipresent.

Investors will do themselves a huge disservice by treating debt funds with a credit strategy like pariahs, and hitting the panic button in reaction to every news story. Instead, a prudent approach will be to acquire an unambiguous understanding of the risk involved, and then decide if they are comfortable taking on the same.

It's worth noting that when investment decisions are based on a combination of fear and ignorance, the results can be rather unpleasant.

When The Portfolio Manager Exits…

Last week, it was reported in the media that portfolio manager Manish Gunwani has quit ICICI Prudential AMC. The recent past has witnessed a fair degree of churn among managers; media reports suggest that more exits are on the cards.

A portfolio manager’s exit is an eventuality that mutual fund investors are bound to encounter at some point. Given that the manager helms the fund, expectedly, his exit can have a bearing on investors.

On their part, investors must evaluate how the manager’s exit will impact the fund. More importantly, they must determine if the fund should continue to find place in their portfolios.

Sadly, investors’ task tends to be complicated by rather diverse perspectives.

Perspectives

From a fund company’s perspective, a portfolio manager’s exit is often treated as a non-event. Typically, the reaction will be: “we have robust investment processes in place; hence manager XYZ’s exit will have no impact on our fund’s performance”.

To be fair to the fund company, it is in its interest to say so. One can’t expect a fund company to admit that a manager leaving is a loss, and that investors could be in for troubled times.

On the other end of the spectrum is the portfolio manager-centric perspective. The latter stems from the belief that the manager is the be-all and end-all for the fund. Hence, all bets are off.

As is often the case, the truth lies between the two extremes.

Individual Brilliance versus Institutionalised Skill

Let’s understand how the investment process works at a typical fund company. The investment team comprises of products specialists, risk management professionals, research analysts, and portfolio managers. Each group performs a specialised task utilising an array of tools and resources.

Investment ideas are originated, debated and vetted before making it to the fund company’s ‘approved’ investment universe. Paper portfolios (also referred to as model portfolios) are created and tracked as an internal guideline. Often each fund is backed by a unique template listing guidelines.

Though the portfolio manager is the first among equals when it comes to running a fund, at times, investment committees also have secondary oversight on funds.

As is evident, a fund company deploys considerable resources to institute investment processes. Hence their typical reaction in response to every manager exit.

So does that make the portfolio manager redundant? Can investment processes eliminate the need for a manager? The answer is--No!

To begin with, not every investment process is necessarily robust. It takes a skilled manager to capitalise on available resources and process. Indeed, in some cases, the manager’s individual brilliance can deliver pleasing results, despite the presence of a less-than-robust investment infrastructure.

The truth is that if processes in isolation could have guaranteed success, then every buy and sell decision would have been made using algorithms, and the portfolio manager would have been an extinct species.

Conversely, those who believe that the manager is the be-all and end-all, must not forget that without the fund company’s resources and instituted processes, a manager could find himself disadvantaged, and perhaps unable to play to his potential. Though the manager is the face of the fund, the forces behind the scenes shouldn’t be overlooked.

Simply put, both investment processes and the manager’s skill contribute to the fund’s success. It would be imprudent to discount either of them.

One Size Doesn’t Fit All

Each fund company has in its arsenal, different investment processes and managers possessing varied skills. Hence the key is to determine which factor contributes more to the fund’s success.

For instance, a combination of a robust process plus a skilled incoming manager can make a manager exit, a non-event. Conversely, if a fund’s success can be largely attributed to the manager’s presence, then his exit should raise a red flag, irrespective of what the fund company claims. In other words, the impact of a manager exit needs to be evaluated on a case-by-case basis.

Admittedly, understanding the nuances of a fund company’s internal workings can be difficult for an investor. That’s where the investment adviser has a part to play in helping the investor make an informed decision.

All in all, a manager’s exit merits consideration, and investors’ response should be based on an in-depth understanding of the facts of the case.

Do Indian Portfolio Managers Eat Their Own Cooking?

For some time now, The Association of Mutual Funds in India (AMFI) has been running an ad campaign “Mutual Funds Sahi Hai”, to propagate the cause of mutual funds. Incidentally, these are good times for Indian asset managers with industry’s assets soaring to record highs. Clearly, investors have taken to mutual funds in a big way.

I thought it will be interesting to find out if portfolio managers who run mutual funds have taken to them as well. To my mind, a manager investing in his fund speaks volumes about both, his commitment to the fund, and confidence in his abilities.

In 2016, market regulator SEBI made it mandatory for fund companies to reveal information about investments made in each fund, by the fund’s portfolio manager, and other key personnel.

I compiled a list of the 50 largest equity funds (excluding hybrids) to study portfolio manager investment patterns. These funds account for roughly 61% of the industry’s equity mutual fund assets, making them a representative sample.

Some disclosures are in order: In the hunt for most recent information, I have perused various documents—Scheme Information Document, Statement of Additional Information, and Key Information Memorandum. However some fund companies continue to disclose information as on 2016, while others have released updated numbers.

Another area of inconsistency is the investment figures. It is apparent that several fund companies have disclosed the current value of manager investments, rather than the sum invested (which is evidently more relevant). The only fund company which stands out in this aspect is SBI Mutual Fund, for having unambiguously disclosed both—the sum invested and current value of investment. This is an area where SEBI needs to step in, to ensure that manager investment are disclosed in a uniform manner across the board.

To analyse the data more efficiently, I broke down investments into the following ranges: 0, INR 1—INR 20,00,000, INR 20,00,001—INR 40,00,000, INR 40,00,001—INR 60,00,000, INR 60,00,001—INR 80,00,000, INR 80,00,001—INR 100,00,000 and over INR 100,00,000. The results are interesting:

Indian Portfolio Managers Don’t Eat Their Own Cooking

Out of the top-50 funds, 20% have no investments from their portfolio managers.

The INR 1—INR 20,00,000 range is the most populated one, accounting for 27% of the top-50 funds.

Cumulatively, the bottom two ranges (no investment, plus INR 1—INR 20,00,000) account for a staggering 47% of the top-50 funds. This is disappointing to say the least.

It can be safely stated that several Indian portfolio managers have little or no confidence in their investment abilities.

Defending the Indefensible

At this point it must be stated that manager remuneration disclosures reveal that an annual compensation of roughly INR 1 crore (INR 10 million) is common even at mid-sized fund companies. So the defence that managers don’t have monies to invest in their funds doesn’t hold water.

Managers can’t take refuge under the pretext of low tenure either, since 80% of the top-50 funds have had their present lead manager at the helm for over two years.  

Finally, a portfolio manager helming a niche fund (such as a money market fund or a sector fund) is perhaps justified in having a small investment. However, the top-50 list is comprised of conventional equity funds, which means that there is no excuse for having zero or tiny investments.

The Counterview

Sceptics might claim that a manager making a substantial investment in his fund doesn’t guarantee performance. But, it is an undeniably important evaluation tool, which demonstrates the manager’s conviction in his investment approach and acumen, and more importantly, his commitment to the fund.

I fail to see why investors should invest in a fund that the manager isn’t entirely committed to. I am certain that like me, most will be wary of the chef who doesn’t eat his own cooking. 

On a final note, perhaps AMFI should initiate an ad campaign targeted at portfolio managers to convince them about the benefits of mutual funds.