Sensex @ 30,000: What Experts Won’t Tell You

The S&P BSE Sensex has breached the 30,000 points mark. Celebratory cakes have been cut, and anchors of business channels have experienced bouts of ecstasy on live television. The print media has published statistics on markets' journey and performance. Clearly, these quarters are abundantly excited.

With investments delivering handsomely, investors have reason to cheer as well. However, not every investor shares the excitement palpable in the media. For some, markets touching record highs has led to anxious moments. These investors have been singed by markets in the past, especially after sharp surges.

For such investors, the all-important question is: Where are markets headed next? Will they continue to surge, or is another crash on the cards?

As is often the case, investors are seeking answers from experts who routinely feature in the media. However, even a cursory glance at quotes and op-eds reveals that experts have chosen to tread the middle path.

For instance, they strike an optimistic note by mentioning India’s strong fundamentals, conducive macroeconomic environment, expectations of robust flows. Simultaneously, they sound a note of caution by speaking about how earnings have failed to keep pace with markets, expensive valuations in certain market segments, and global factors such as the US Fed's stance.

It is evident that investors who are seeking an unambiguous answer from experts will be disappointed.

And, here’s why—No one knows where markets are headed in the near-term. While experts can make reasonable estimates of how markets will play out over the long-term, predicting near-term movements is anyone’s guess.

The trouble is that no expert will risk losing his ‘halo’ by publicly saying “I don’t know how markets will behave in the near-term”. Likewise, no print publication or channel is interested in quoting an expert who says so, or simply advises investors to focus on the long-term.

As a result, investors are subjected to convoluted and non-committal views from experts.

What investors must do

On their part, investors would do well to look inwards, instead of relying on experts.

Investing is a personalised activity. In other words, a ‘one size fits all’ approach doesn’t work. Hence, investment decisions must be made in line with one's risk appetite, temperament, and investment goals.

For instance, investors who are overly worried that an imminent crash might wipe out their gains, shouldn’t hesitate to book profits. In particular, investments that don’t agree with their profile; now is a good time to exit them at a gain.

Investors who are at ease with the vagaries of markets should continue to invest in line with their plans. For such investors, any downturn will present an attractive investment opportunity. 

Investors who find themselves between the extremes, can consider adopting a wait and watch approach.

The key lies in making a choice that works for you, and standing by it. That will lead to a far better investment experience, than relying on an expert who speaks half-truths.

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.

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