When The Portfolio Manager Quits…

Just when one thought that the debate on debt funds taking credit risk would be the mutual fund industry’s final major event for the year, comes the news of Anoop Bhaskar’s exit from UTI Mutual Fund. Apart from acting as the Head of Equity, Bhaskar also shouldered portfolio management responsibilities. Bhaskar contributed significantly to the equity research and portfolio management functions at the fund company. It came as no surprise that his stint coincided with the performance of several equity funds looking up. 

Investors in funds which Bhaskar ran, are faced with a familiar dilemma—what should be done, now that the portfolio manager has quit. Should they stay invested, is it prudent put fresh investments on hold, or should they liquidate their investments? 

When a prominent portfolio manager quits, fund companies react on expected lines—‘we have strong investment processes’, ‘the exit will not affect the performance of our funds’ and so on. To be fair, what else can they say? On their part however, investors need to be more circumspect. 

One size doesn’t fit all

At the outset, let me bust the myth that there is a standard course of action to be followed when the portfolio manager quits. Each case is different, and investors need to act accordingly. 

For instance in early 2014, when K.N. Sivasubramanian (CIO-Franklin Equity and portfolio manager) exited Franklin Templeton Mutual Fund, it wasn’t as sharp a break as it might have seemed. For those tracking the fund company, it was evident that Anand Radhakrishnan was being groomed to take over from Sivasubramanian. Furthermore, the presence of a skilled and stable team of managers and analysts meant that investors’ interests were safeguarded. Expectedly, the transition was smooth and on that count, investors had no reason to review their investments.

UTI Mutual Fund’s case is rather different. The fund company has in its ranks skilled and experienced managers such as Swati Kulkarni. However, to my mind, no one stands out as the heir apparent to Anoop Bhaskar. The replacement will have big shoes to fill. 

That said, at present, there is no cause for investors to hit the panic button. But there is certainly a case for closely monitoring developments. It will be interesting to find out who is chosen to head up the equity management function, and if that alters the working of the function.

Change can be multifaceted  

When a new manager takes over, fund companies are known to go the extra mile to convince stakeholders (investors, distributors and advisers) that the fund’s character will remain unchanged. That’s an area which must be scrutinised on an ongoing basis.    

For instance, a large-cap fund which under the erstwhile manager was a benchmark-hugger, could turn into a benchmark-agnostic fund under the new manager. Likewise, a mid-cap fund wherein the erstwhile manager deployed a value-styled approach could mutate into a high-growth styled fund under the new manager. 

In both cases, while the funds’ market-cap profile didn’t change, their intrinsic character underwent a makeover. From an investor’s perspective, there is a need to evaluate if the fund in its new avatar can continue to play its predesignated role in the portfolio. 

In conclusion, the portfolio manager’s exit is an event that merits investor attention. Investors would do well to neither panic, nor be indifferent. Finally, they must seek assistance from their adviser to help gauge the impact of the exit, and decide on the future course of action.

Should Fund Houses Fear Big-Ticket Investors?

Media reports suggest that a questionnaire from the country’s largest bank -- State Bank of India (SBI) has sent several fund houses running for cover. Apparently SBI invests substantial monies in debt mutual funds; last week, the bank sent a questionnaire to fund houses, seeking information about their investment practices and policies. Among others, SBI has asked for information on fund houses’ policy for compensating investors in the event of a loss incurred due to a default or downgrade. Clearly, the JPMorgan Mutual Fund episode continues to rankle investors.

Investors wanting to know more about a fund house’s investment practices is understandable. Indeed, one expects them to perform such due diligence before making an investment, rather than after investing. The curious part pertains to seeking compensation in the event of a loss. It doesn’t take a genius to figure out that mutual funds are market-linked instruments; hence the possibility of incurring a loss cannot be ruled out. Given that fund houses operate as pass-through structures, expecting them to compensate investors for a loss incurred in the normal course of investing seems farfetched. So why would a behemoth like SBI seek such information? For the answer, let’s step back in time.

Hail big-ticket investors!

The mutual fund industry’s fondness for big-ticket investors (institutions and high net-worth individuals) is no secret. Over the years, this liking has manifested itself in various forms: institutional plans with liberal expense and load structures (versus retail plans), launch of fixed maturity plans that enabled a handful of big-ticket investors to make quasi-PMS investments. In the 2008 meltdown, several fund houses did their best to protect large investors in debt funds, by transferring illiquid securities to equity funds. In effect, liquidity was provided to large investors at the cost of retail investors (who largely invest in equity funds). Over time, it took intervention from the market regulator SEBI (in the form of abolishing differential expense and load structures, and instituting the 20-25 rule, among others) to create a level playing field. 

But then old habits die hard. Perhaps some big-ticket investors have a sense of entitlement which leads them to believe that mutual funds should be structured as  risk-free (at least in part) investments for them.           

The counterview 

Data from AMFI reveals that as of Sep 2015, debt and liquid funds accounted for roughly 67% of mutual fund assets. In both the segments, a lion’s share (62% in debt funds and 92% in liquid funds) was held by institutional investors. Simply put, a bulk of mutual fund assets come from institutional investors. Fund houses can claim that they are obligated to offer these big-ticket investors preferential treatment. But such thinking is flawed.

Any serious fund house knows that long-term assets are the key to survival and growth. Yet again, data reveals that fund categories wherein retail investors dominate tend to display longer investment horizons versus categories wherein institutional investors dominate. Hence, it is in the interest of fund houses to offer retail investors a fair deal.

If fund houses find themselves in a vulnerable position, they must shoulder at least part of the blame for having failed to democratize investments. Several fund houses have been guilty of chasing short-term institutional monies and failing to develop a strong retail investor base.

It will be naïve to believe that any fund house will offer to compensate SBI for losses incurred in its schemes. It’s high time self-respecting fund houses send an unambiguous message: The era of offering preferential treatment to big-ticket investors (and treating retail investors as second-class citizens) is over. It is in the best interest of fund houses to come to terms with this realisation and act on it at the earliest.

Of exit loads, fund houses and distributors - 2

Yesterday...
All my troubles seemed so far away,
Now it looks as though they're here to stay,
Oh, I believe in yesterday...

(Yesterday – The Beatles)

This iconic song pretty much sums up the mood among several mutual fund distributors. For distributors habituated to attractive compensation structures and easy money, the new-look mutual fund industry has come as a rude shock. In one deft move (scrapping entry loads), the regulator changed the rules of the game. Further, the provision for uniform exit loads plugged the loophole that some would have liked to exploit.

Newspaper reports suggest that fund houses’ pleas to roll back/modify the entry load provision has been rejected by SEBI. Some fund houses have decided to compensate distributors by paying them an upfront commission in any case. Distributors on their part are tweaking their business models. Fee structures are being charted out; new value-add offerings are being introduced. Terms like ‘unbiased’, ‘independent’ and ‘research-driven’ are now liberally used in communication. Clearly, the mutual fund industry is in unchartered territory and ‘wait and watch’ is the new mantra.

Despite the gloomy picture being painted by most, it would be safe to state that the scenario isn’t as bad as it is made out to be. In fact, things could become markedly better for all the participants i.e. investors, fund houses and distributors.

Conventionally, distributors have worked on the ‘assets under management’ model i.e. more investments their investors made, higher was their pay-off. Broadly speaking, the latter came from the entry load, the trail commission and ancillary compensation/benefits provided by fund houses. While entry loads have been done away with, distributors can now demand compensation from investors directly. Also, unlike loads, this compensation is not regulated. It has been left to be mutually determined by the investor and the distributor.

Distributors argue that investors are unlikely to be willing to compensate them. There is some merit in that argument. Investors habituated to filling mutual fund forms and writing cheques for the investment amount, might resist the new arrangement initially. However, once they are convinced of the value that the distributor adds to the investment process, the resistance will subside.

The importance of quality advice and service cannot be overstated. The distributor has a vital role to play in aiding the investor achieve his financial goals. Making an investment plan, successfully managing and tracking an investment portfolio are no mean tasks. And once the distributor effectively communicates how his services can aid the investor, there’s no reason for the investor not to come on board.

Sure, distributors who fail to add value and work in the investor’s best interests might see their business dwindle. But that would only be a fair and natural consequence.

From the fund houses’ perspective, it’s an opportunity to have access to serious, long-term money. It isn’t entirely uncommon to see ill-advised investors invest monies simply to ride the rising markets. With quality advice being made available to investors, we could see the rise of a breed of informed investors who are willing to stay invested for the long-haul. Investors who don’t panic when markets experience downturns; instead they see the same as an opportunity to make investments at attractive prices. Now wouldn’t fund houses love to have such investors investing in their funds? Also, it would be fair to assume that fund houses will handsomely compensate distributors facilitating serious investors and long-term monies, for their efforts.

As for the investor, it's options galore. Some distributors will operate on the ‘transaction’ model i.e. use technology to offer investors a low-cost platform for making investments, others will bank on providing quality advice and then there will be those whose USP will be personalised service. In most cases, there will be an overlap. From the investor’s perspective, the importance of being aligned with the right distributor has never been higher. Investors will have to thoroughly evaluate the proposition offered by each distributor and select the one that best works for them.

For instance, if a distributor boasts of his research set-up, quiz him about the same, the size of his team and their experience. If a distributor claims to be independent, enquire how he ensures that his independence is not compromised with. If ‘low-cost investing’ is the platform on offer, find out how the same compares with other distributors. The onus to conduct a thorough due diligence and make an appropriate choice lies with the investor.

It won’t be surprising if investors choose to be associated with multiple distributors; for instance, the advice could be sourced from one distributor and transactions made with another.

As mentioned earlier, the mutual fund industry and its participants are in unchartered industry. However, despite what the naysayers would want you to believe, it need not be all gloomy. Remember the adage about – it’s not the cards you are dealt, but how you play them. The ‘how you play them’ part could hold the key for the mutual fund industry, going forward.

Here comes the sun,
Here comes the sun,
And I say it's all right,
Little darling, it's been a long cold lonely winter,
Little darling, it feels like years since it's been here,
Here comes the sun, here comes the sun,
And I say it's all right...

(Here comes the sun - The Beatles)

Of exit loads, fund houses and distributors - 1

The line, it is drawn, the curse, it is cast
The slow one now, will later be fast
As the present now, will later be past
The order is rapidly fading
And the first one now, will later be last
For the times, they are a changing

(The Times They Are A-Changin'- Bob Dylan)

To say that times are changing for the mutual fund industry would be stating the obvious. In all fairness, not many anticipated the same; perhaps, some are still struggling to come to terms with it. Nonetheless, change is here and it’s here to stay.

Retail investors, who have conventionally been at the receiving end of whims and fancies of fund houses and distributors alike, have become an empowered lot. Thanks to the regulator’s intervention, a level playing field has been created. Fund houses had barely recovered from the SEBI regulation abolishing entry loads, and now the regulator has taken aim at exit loads. SEBI has ruled that fund houses can no longer charge differential exit loads based on the investment amount.

First, let’s discuss what an exit load is. Simply put, it is a charge/penalty levied on an investor for exiting an investment before a stipulated period. For instance, open-ended equity funds may require investors to be invested for at least 12 months, in order to avoid paying an exit load. The rationale for the same is quite simple. Each fund has a distinct nature and it should attract monies for a commensurate time frame. Equity funds typically require investors to have a much longer investment horizon vis-a-vis say a liquid fund. Now an investor, who gets invested in an equity fund for a shorter time frame, might on exit, force the fund manager’s hand, and in the process hurt the prospects of long-term investors in the fund. Hence, the exit load which acts a deterrent for erring investors.

However, fund houses chose to tweak the exit load provision to accommodate big-ticket investors like high networth individuals (HNI) and corporates. This was done by creating differential exit loads based on the investment amount. For example, a retail investor investing Rs 5,000 was charged an exit load of 1.00% for liquidating his investment before 1 year from the date of investment; however, an HNI investing Rs 5 crores (Rs 50 million) in the same fund was outside the purview of exit loads. If you are wondering why fund houses perpetuated such disparity, the answer is pretty straightforward. A higher asset size equals higher revenue for the fund house. Typically, an HNI/corporate investor brings in a substantial amount of money i.e. he significantly contributes to the fund house’s asset size and revenues in turn. Hence, fund houses' willingness to ‘accommodate’ them.

There are some who justified differential entry and exit loads on the grounds that bulk transactions are subsidised in all walks of life. Sadly, the difference between buying grocery at a supermarket and investing in a mutual fund is lost on such individuals.

Thanks to SEBI, fund houses will now have to shed their prejudices and treat all investors alike going forward.

The reason for entry loads coming under focus at this stage is quite interesting. This phenomenon can be traced to the SEBI directive abolishing entry loads. Therein, the regulator had stated that 1.00% of the monies collected as exit loads can be utilised by fund houses to compensate distributors and meet marketing and distribution expenses.

Expectedly, fund houses saw an opportunity to aid distributors by implementing a stiffer exit load structure. The latter meant that either investors would pay higher exit loads or be required to stay invested for longer (vis-a-vis the past) to avoid paying an exit load.

Fund houses would like us to believe that the move to hike exit loads was only intended at promoting long-term investing. And perhaps it was. But then, isn’t it fair that all investors (irrespective of the investment size) be exposed to the virtues of long-term investing?

Had differential exit loads not been scrapped, the new (read stiffer) exit loads would have been borne by retail investors, since investments made by HNIs and corporates were largely outside the purview of exit loads in the earlier regime. SEBI has ensured that the exit load burden (and thereby the onus to indirectly compensate distributors) is equally borne by all investors.

Clearly, the excesses in the mutual fund industry were not lost on the regulator who has decided to champion the investor’s cause. The abolition of entry loads and differential exit loads are among several changes that will have a lasting impact on the mutual fund industry.

Any discussion on the mutual fund industry’s metamorphosis cannot be complete without deliberating on distributors. Over the years, the importance of distributors as a link between fund houses and investors, and more importantly as fund houses’ allies has grown by leaps and bounds. And now, the distribution mechanism is all set for a major overhaul as well. More on that in the concluding part of this article.

What happened to close-ended funds?

Circa 2006-07, close-ended funds were the season's flavour. Fund houses were busy convincing investors to get invested on the premise that close-ended funds furthered the cause of 'long-term' investing. Investors had a plethora of options to chose from since close-ended NFOs (new fund offers) of every conceivable kind were launched i.e. mid-cap, flexi-cap, thematic, fund of funds and tax-saving.

The genesis of close-ended funds
When equity markets hit a purple patch in 2003, fund houses capitalised on the same by launching equity fund NFOs. Most NFOs were of the open-ended variety. Fund houses were permitted to charge initial issue expenses (6% of corpus) to the fund and amortise the same over a period time. Initial issue expenses were largely used to meet marketing and distribution expenses. As a result, distributors were handsomely rewarded for their efforts in asset mobilisation.

A spanner in the works came in the form of a SEBI guideline that scrapped initial issue expenses on open-ended NFOs. Now, fund houses were required to meet NFO-related marketing and distribution expenses from the entry load; the norm was 2.25% of the sum invested. But close-ended NFOs were out of the purview of this ruling. While fund houses were permitted to charge initial issue expenses on close-ended NFOs, the trade-off was that they were prohibited from levying an entry load. The choice between initial issue expenses and entry load was a no-brainer. The result was a deluge of close-ended NFOs.

It would be unfair to paint all fund houses and close-ended NFOs with the same brush. Some close-ended NFOs did offer a truly innovative investment proposition. However, ignoring the marketing aspect would be naive.

The present scenario
It can be safely stated that close-ended funds are a forgotten breed now. Maybe, it had something to do with a subsequent guideline (January 2008), wherein SEBI decided that close-ended NFOs be treated on par with open-ended NFOs i.e. they would be permitted to charge an entry load and the provision to charge initial issue expenses was scrapped.

While close-ended funds may not feature on the priority lists of fund houses, it's a different scenario for investors. Several investors got invested in close-ended NFOs and continue to hold the same in their portfolios. Also, since then, markets have had quite a journey - an ascent to record highs, followed by a sharp downturn, and a recovery of sorts. It would be interesting to study how close-ended funds have fared so far.

The performance
Of the several close-ended funds launched in the 2006-08 period, 4 have a 3-Yr track record now. The following table shows how they have fared vis-à-vis comparable open-ended offerings from the same fund house and their respective benchmark indices.

	3-Yr (%)
Franklin India Prima	8.2
Franklin India Smaller Companies ©	6.6
CNX Midcap	16.8
HDFC Premier Multi-Cap	14.1
HDFC Long-term Equity ©	9.1
S&P CNX Nifty	15.2
ICICI Prudential Dynamic	18.2
ICICI Prudential Fusion ©	6.5
CNX Nifty Junior	18.7
Tata Tax Saving	12.6
Tata Tax Advantage 1 ©	14.3
BSE Sensex	14.6

(NAV and index data as on July 24, 2009. © indicates close-ended fund. NAV data sourced from www.amfiindia.com. Index data sourced from www.bseindia.com and www.nseindia.com. All data in CAGR terms)

As can be seen in the table above, close-ended funds have failed to match their benchmark indices over the 3-Yr period. Furthermore, with the exception of one fund, others have failed to match comparable open-ended funds from the same fund house. Even a cursory glance at performance of other close-ended funds (ones that have been in existence for less than 3-Yrs) will reveal that largely their performance is nothing to write home about.

It ain't over, till it's over
Critics might argue that the aforementioned funds need not be a representative sample of the entire close-ended funds category. Fair enough. But few would dispute that close-ended funds have failed to impress so far.

Fund houses are likely to justify the mediocre showing posted by close-ended funds on the grounds that these are early days. Given that most close-ended funds have a 5-Yr tenure, passing any judgement at this stage would be premature. Also, several funds have a provision for conversion into open-ended funds on maturity. Hence, should they fail to deliver in their close-ended avtaar, investors can continue to stay invested and exit the same at a more opportune time. While there might be some merit in the former argument (early days for funds), the latter certainly doesn't hold good.

Here's why - investments in close-ended funds were made on the premise that they would enable fund managers to make long-term investment decisions i.e. fund managers would not be weighed down by factors like redemption pressure and short-term market occurrences, that typically plague open-ended funds. When investors agreed to forsake liquidity (make a 5-Yr commitment) and bear initial issue expenses, the trade-off should have been a superlative performance. The least investors would expect is for close-ended funds to deliver a better showing than open-ended funds. And should close-ended funds fail to deliver, investors have every right to feel aggrieved.

What investors must do
Investors would do well to appreciate that not every promising proposition translates into a sound investment avenue. On paper, a close-ended fund with a defined maturity horizon and corpus sounds like an interesting idea; however, with the benefit of hindsight, it can be safely concluded that not every close-ended fund will live up to the promise. This underscores the importance of seeking diversification and a track record while making investment decisions.

Also, investors must keep track of their close-ended fund investments. Be patient and give them adequate time to prove themselves. Despite this, if they fail to deliver, don't hesitate to exit them after taking into account factors like the exit load. Perhaps an alternative fund with a similar investment proposition might be a better bet.

Much ado about 'no entry load'

All right. So, the Securities and Exchange Board of India (SEBI) has decided that mutual funds will no longer be permitted to charge an entry load. And all hell has broken loose! Newspapers are carrying articles with comments from 'experts' and 'senior officials' at fund houses running down the move; a lot of emphasis is being laid on how this step will hurt the mutual fund industry. But is that correct? Can a step that is evidently pro-investor be detrimental to the industry?

Let's take a look at what SEBI has proposed. Following is an extract from a press release posted on SEBI's website:

"There shall be no entry load for the schemes, existing or new, of a Mutual Fund. The upfront commission to distributors shall be paid by the investor to the distributor directly. The distributors shall disclose the commission, trail or otherwise, received by them for different schemes/ mutual funds which they are distributing or advising the investors."

The guideline suggests that the practice of fund houses deducting an entry load (from the sum invested) and paying the same to distributors (investment agents/advisors) as upfront commission will be discontinued. Instead, the investor will have to compensate the distributor for the services rendered. Also, distributors shall be obliged to reveal the total commission they earn from various mutual funds.

So let's see, what's causing all the hoopla? Have distributors been deprived of their livelihood? Does the regulation suggest that henceforth distributors will have to treat selling mutual funds as a philanthropic activity? No. So why all the fuss? Here's why. Thanks to this step, distributors have been made accountable. They can no longer operate with a "the more I sell, the more I will earn" mindset. With an assured income of 2.25% or thereabouts from the entry load, aspects like quality of advice and service were rarely granted any importance. However, that modus operandi is now history. Several distributors will have to kiss a tearful goodbye to the 'easy money' route. And this is where all the agony stems from!

Any distributor who is confident about the quality of services he offers, should welcome this step. Nowhere does the guideline suggest how much income the distributor can demand from the investor. So if the distributor provides quality advice that is consistently in the investor's best interests and backs it with top-notch service, he could potentially demand more than the 2.25% that was available to him via the erstwhile entry load. Hardly a reason to complain!

Now for the second part of the guideline - disclosing all commission earnings. Again, distributors only have themselves to blame. Having built a reputation for selling mutual funds that offer them the highest commission, mis-selling continues to be common practice in the mutual fund industry. SEBI is simply trying to incorporate greater transparency in the investor-distributor association. Distributors who do not engage in any malpractice have no reason to fear. They should be able to justify why they are recommending a given fund vis-à-vis another.

Some fund houses are apparently aggrieved since they believe that the mutual fund industry will suffer, since distributors will gravitate towards insurance products offering better commission. Hence fund houses will end up with lesser assets to manage. Of course, a smaller asset size translates into lesser income for the fund house.

Here's a counterargument - if the mutual funds on offer are attractive enough and can aid the investor in achieving his investment goals, he will demand them and thereby create a demand. And the onus to ensure that funds are attractive lies primarily with the fund house. Also, if a fund house feels that distributors deserve to be better compensated, it is free to cough up additional benefits out of its own pockets. Remember the regulator only stipulates how much expenses can be charged to the fund (i.e. borne by the investor). Any fund house/AMC which believes that distributors are being short-changed, should feel free to reward them out of its own coffers.

Time and again, fund houses have failed to act in the best interests of the investor. Their partisan attitude towards distributors and indifference towards investors has been disappointing to say the least. Let's hope this time around better sense prevails and they don't create any roadblocks in the implementation of this directive.

As for investors, they couldn't ask for more. First, they were given the opportunity to invest directly with the fund house, thereby bypassing the distributor and avoid paying an entry load. Now with the guideline to scrap the entry load, they can negotiate with the distributor and arrive at a fair price for the latter's services. The onus to make the most of this opportunity lies with investors.

Kudos to SEBI for taking a stand for investors!

Distributors and fund houses - keep your chin up. This round goes to investors!

Look who's talking!

Mutual funds are back with a bang! Pick up any newspaper and you are bound to come across a mutual fund related write-up or advertisement. Given the surge in equity markets, the performance of mutual funds has started looking up. And fund houses are sparing no effort (explicit or implicit) to spread the gospel of mutual funds. There are articles eulogising the impressive showing delivered by mutual funds in the recent past; also, the fact that the mutual fund industry now holds a record assets under management (AUM) size has been well-documented. Fund managers are busy giving out interviews highlighting how mutual funds will hold investors in good stead over the long-term. Dividends are being declared in a hurry by several funds to prove their prowess. Finally, some new fund offers (NFOs) have already been launched (more on this later in the article) and several others are on the way. All in all, it can be safely stated that mutual funds are back with a bang!

Circa October 2008
Not too long ago (October 2008 to be precise), the scenario was radically different. Equity funds had been hit hard by the sharp decline in equity markets; even 3-Yr performance numbers were in negative territory. Debt offerings like fixed maturity plans (FMPs) and liquid/liquid plus funds had come under the scanner on account of the liquidity crisis; questions were being raised about the quality of investments made by several funds. Simply put, mutual funds had become everyone's favourite 'whipping boys'. While all the criticism may not have been justified, some of it certainly was.

Interestingly, the response of fund houses to the demanding situation was rather curious. Most fund houses went into a 'silent' mode and simply chose not to react. When relationship managers were contacted for information about their funds, the standard response was, "everything is fine; there is nothing to worry about". Requests for one-on-one interviews with fund managers were either instantly turned down on the grounds that the fund manager was busy or stalled with the excuse - "we'll get back to you on this one". While some fund houses/fund managers were willing to go on record about the nature and quality of their fund portfolios, they were strictly in a minority.

Odd isn't it. In a time of crisis, fund houses, instead of communicating with investors to assuage their concerns, chose to go into hiding. And now, when the going is good, fund houses are acting like 10-yr old over-energetic blabbermouths who can't keep mum. That tells you something about fund houses, doesn't it?

As for the NFOs, at any sign of rising markets and a revival in investor interest, they make a comeback. Already, we have had a round of the 'target return' NFOs. Simply put, these are funds wherein there is an inbuilt clause for booking profits when a certain return (as specified by the investor) is clocked. In most cases, the profits are booked and invested in a debt fund from the same fund house. For investors who were ruing the fact that they didn't book profits when markets peaked in January 2008, only to see the value of their investments plummet subsequently, these NFOs struck a chord.

Here's a thought - is it prudent for mutual funds to book profits for investors or is that something investors should be independently dealing with after taking into account factors like their individual financial goals, the investment scenario and the performance of their investment portfolio as a whole. Also, let's not forget that regularly 'booking profits' for every individual investor at a fund level, just might force the fund manager to prematurely sell some quality stocks from his portfolio. This in turn, could be detrimental to the long-term interests of the fund.

But given the receptiveness shown by investors, fund houses were only more than happy to launch a slew of 'target return' funds. Some introduced the facility to book profits in their existing funds. Of course, the fact that even after booking profits, (on account of transfer of profits booked into a debt fund) there is no fall in the AUM of the fund house doesn't hurt the latter's cause. Rest assured, with the markets moving northwards at a brisk pace, it's only a matter of time before a number of NFOs hit the markets.

What investors must do
Given that fund houses have failed to distinguish themselves, it is fair to state that investors would do well not to blindly follow them while making investment decisions. Going forward, fund houses will try to entice investors by making them believe that all is hunky dory and now is the time to get invested lock, stock and barrel. Can't blame them, it's the AUM that translates into income for them. Hence, higher the AUM i.e. more investments made by investors, the better it is for fund houses.

On the other hand, investors need to be a lot more pragmatic. They should not get carried away by all the hype being whipped up by fund houses. Instead, they should use the downturn and despondency that they witnessed and experienced not too long ago, to make a fair evaluation of their risk-taking ability. This can help them determine what portion of the investment portfolio should be allocated to mutual funds. While no one would dispute the ability of well-managed mutual funds to add value to investors' portfolios, there is certainly a need to guard against making investments in a reckless manner.

Do your mutual funds stand the test of character?

'In times of adversity, true character is revealed' - that's an adage relevant not only to humans, but also investment avenues like mutual funds. Any analyst worth his salt will vouch for the fact that in rising markets, it is hard to distinguish the men (proven and invest-worthy funds) from the boys (also-rans). Buoyed by conducive market conditions, even mediocre funds can deliver an extraordinary performance. Often the mantra is - take on above-average risk and ride the wave.

But when the tide turns (as it has over the past 12-14 months), a fund's mettle is truly tested. The last few months have been particularly interesting. With the markets hovering around the 8,000-point mark, despondency had all but set in. And then came an uptick that took everyone by surprise. Speculation regarding 'the worst being over' and 'the commencement of a recovery' was doing the rounds. But alas, the victory celebrations seem to have been interrupted by the impending election results and the possibility of another hung parliament.

If you are an investor, it can be safely stated that these aren't happy times. The uncertainty is certainly not helping. But all is not lost. On the contrary, this is an opportune time to evaluate your mutual fund portfolio.

The evaluation needs to go beyond the obvious i.e. how a given fund fared on the downside. Sure, the latter is important and will play a significant part in the process. However, an equally vital evaluation will pertain to identifying the fund's 'true character'.

Each fund has a professed investment style; in mutual fund parlance, this is referred to as the fund's positioning. Say Fund A in your portfolio may be positioned as a mid cap fund. Now is the time to determine if the fund manager has walked the line and adhered to the stated investment style i.e. irrespective of the market conditions, does the fund continue to be invested in mid cap stocks in line with its investment objective/positioning.

There will be a case for raising a red flag if you come across the professed mid cap fund making substantial investments in the large cap segment, simply because the latter has been less impacted during the downturn.

Then there are funds which state that they will be fully invested at all times i.e. they will refrain from taking cash calls. This investment style often flows from the philosophy that fund houses are custodians of investors' monies for investment purpose as opposed to holding cash (making investments in current assets).

The red flag scenario: A fund house which believes in holding portfolios that are fully invested at all times, performs a volte-face and holds a substantial portion of its portfolios in cash to minimise the brunt of falling markets.

Hybrids i.e. balanced funds and monthly income plans (MIPs) are often referred to as tools of asset allocation, on account of investments in both equities and debt. Theoretically, by diversifying across asset classes, hybrids are better equipped to safeguard the investor's interest when a given asset class hits a rough patch. When equity markets run into rough weather, a balanced fund can score over a conventional equity fund on account of its debt holdings.

Now is the time to find out if the hybrids in your portfolio are playing their part as required. Failing to do so (say a balanced fund that insists on being largely invested in equities akin to a conventional equity fund) defeats the purpose of investing in a hybrid.

Why it is vital to conduct the aforementioned exercise
Wondering why it is vital to conduct the aforementioned exercise (incidentally, the above list is not a comprehensive one; these are some among several tests that can reveal a fund's true character). Another question could be that some of the 'red flag' scenarios were aimed at protecting investors' interests. Hence the same should not be held against the fund house. Here's why this argument doesn't hold good.

A fund is not an 'end', it is simply a 'means' to achieve an end. In other words, the fund should find place in a portfolio because it can play a specific part. And the part played by the fund is inextricably linked to its nature/unique characteristics. Should the fund deviate from its defined character, there's a fair chance that the portfolio might fail to deliver on expected lines and in turn, the investor may fail to achieve his financial goals.

What you must do
As an investor, you must ensure that you are invested in funds that have a defined character and a reputation of not having deviated from the same. Furthermore, once the investments are made, a review of the funds' performance (including adherence to their stated investment style) must be made. The financial planner/mutual fund advisor will have a critical role to play in the review process; expectedly, the same must be conducted on an ongoing basis over a period of time. The advisor will be equipped to distinguish minor aberrations from significant deviations. And given the challenging investment scenario we are faced with at present, the resolve of even the most resolute fund houses and fund managers is likely to be tested. Hence, the importance of conducting a thorough review now!