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.

Of Bollywood, Mutual Funds, and INR 100 Bn AUM

Some of my friends are Bollywood aficionados. They are informed of not only which movies are being screened, but also their box office numbers. As a result, even I have become familiarised with terms such as “the 100 crore club”. For the uninitiated, apparently box office collections of at least INR 100 crores (INR 1 billion) is a parameter for a movie to be considered a success.

Oddly, a somewhat similar scenario is brewing in mutual funds. Thanks to a combination of steady inflows and rising markets, several equity-oriented funds have an asset size exceeding the INR 10,000 crores (INR 100 billion) mark.

However unlike box office numbers, growing assets of mutual funds are giving some investors and distributors sleepless nights.

Is the evaluation parameter apt?

An evaluation parameter must be based on sound logic for it to be relevant.

Let’s consider the 100 crores mark for movies. Say movie “ABC” costs INR 30 crores to make, and its box office collection is INR 70 crores. Compare this with movie “XYZ”, which costs INR 90 crores to make, and clocks proceeds of INR 110 crores.

Now if grossing INR 100 crores is the benchmark of success, then “XYZ” has succeeded, while “ABC” is a failure. However, if cost is considered, it is apparent that “ABC” is more profitable (hence, more successful) versus “XYZ”.

Clearly, selecting an apt benchmark is vital. This principle holds good in the case of mutual funds too.

Does size matter?

Asset size can matter because a mutual fund operates within the restraints of liquidity, market cap, and availability (listed stocks). That said, jumping to a conclusion such as “large asset size=bad, and small asset size=good” would be naive.

Let’s consider small and mid-cap funds. Here, a large asset size can pose challenges in the form of market-impact cost, the opportunity cost of having to spread trades out over longer periods, and liquidity management.

Conversely, a large asset size offers economies of scale. In India, regulations ensure that the expenses charged to a fund reduce, as size grows. In categories such as liquid funds wherein margins are wafer thin, a competitive cost structure aids the investor’s cause in no small measure.

Furthermore, in certain segments of debt markets (such as government securities), the minimum lot size is substantial. As a result, a small-sized fund may not be able to invest in it, thereby depriving investors of a wholesome investment experience.

Simply put, no blanket rule can be applied. The relevance of a mutual fund’s asset size depends on the individual specifics of each case.

Is INR 100 billion a sacrosanct number?

It’s hard to figure out why there is so much focus on the asset size of INR 10,000 crores for equity funds. To begin with, that number isn’t backed by any reasoning. Furthermore, as we learned from the case of the “100 crore club”, a number in isolation means little.

Let’s take the case of a large-cap equity fund with assets of INR 17,000 crores (INR 170 billion). In absolute terms, one might be inclined to believe that the fund’s size is substantial.

However, the size amounts to roughly 0.36% of the S&P BSE 200’s (an apt benchmark index) free-float market cap. In other words, the fund isn't really large.

Conversely, a small-cap fund with a size of INR 5,000 crores (substantially lower than the "hallowed" INR 10,000 crores) could struggle to freely invest without hampering performance.

What investors must do

Instead of focusing on the asset size in isolation, investors would do well focus on the consequences of a growing size.

To begin with, not every portfolio manager is skilled enough to manage a large-sized fund; neither is every investment style adaptable to a large fund.

Look for signs of stress—the manager’s investment style changes sharply, the portfolio acquires a tail which doesn’t add value, the long-term showing consistently falters.

A growing asset size could result in the fund’s character undergoing a fundamental change. For instance, a fund that made its mark as a small/mid-cap fund could end up becoming a large-cap fund.

In such a scenario, investors must evaluate if the fund yet merits a place in their portfolios. If the intention was to invest in the small/mid-cap segment, then corrective steps are in order.

Finally, in cases wherein despite a growth in asset size, there is no discernible change either in the portfolio manager’s investment style and the fund’s character, investors should ignore all the noise and stay invested.

Why Investors Shouldn’t Deify the Portfolio Manager

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.

Mr. Portfolio Manager: It’s About Conviction, Not Guarantees

Over the years, in my several interactions with portfolio managers most have claimed to be big investors in funds they run. Perhaps it was politically correct to do so. Then again, there was no way to independently verify their claims. However, with market regulator SEBI mandating that investments made by managers and the fund company's top brass be disclosed, the scenario has changed.

The disclosures have been startling to say the least. Several long-tenured managers running large diversified funds have nominal investments to show for, while others have chosen not invest in their funds. It can be safely stated that the principle of having ‘skin in the game’ hasn’t been embraced by many managers.

Recently, a manager who has no investments in his funds came up with a novel justification. He stated that a ‘manager investing in his own fund doesn’t guarantee performance’; hence, his investments (or lack of them) are immaterial. To clarify, he isn’t the only manager to have taken that stand. In my opinion, this line of thought is both naive and flawed.

Given their market-linked nature, mutual fund investing entails taking on risk. While the degree of risk may vary depending on the kind of fund chosen, risk is pervasive nonetheless.

So how do investors mitigate risk? By performing an evaluation. For instance, some may focus on quantitative parameters such as past performance, risk-return showing, while others emphasize on qualitative factors—manager skill, investment process et al. It isn’t uncommon for investors to combine the two either.

The portfolio manager’s investments in funds he runs is yet another evaluation tool. A manager investing substantial monies in his funds demonstrates conviction in his investment approach and acumen. It’s a classic example of putting one’s money where the mouth is.

None of the evaluation parameters can guarantee performance. But that in no way diminishes their relevance. Of all people, a portfolio manager should be aware that there are no guarantees in his domain. Investing in markets akin to a business of risk, not a business of guarantees. Does the fact that there is no guarantee of returns, prevent the manager from exhorting investors to invest in funds he runs?

I have no doubt that some managers will continue to steer clear of investing in funds they run. But they would do well not to trivialise the importance of having ‘skin in the game’ using inane arguments. As for investors, I am certain that like me, most will be wary of the chef who doesn’t eat his own cooking.

Stupid Portfolio Manager vs. Ignorant Portfolio Manager

Aggression seems to be the flavour of the season. Several politicians routinely breathe fire; at present, students at a New Delhi campus are in a belligerent mood. No discussion on Indian cricket is complete without the mention of aggression; likewise, a bespectacled newscaster known for his confrontational demeanour tops the TRP charts. And just when one thought it couldn’t get any more interesting, aggression has reached the mutual fund industry.

Recently, the promoter of an asset management company published a piece insinuating that competing portfolio managers are stupid. His contention is that since the NDA government assumed charge at the centre, bogus/hyped earnings estimates have been doing the rounds. Hence, equity portfolio managers who believed in and acted on the same are stupid. Furthermore, portfolio managers who didn’t fall for the hype, but failed to communicate their misgivings (on lucrativeness of equities) to investors are dishonest.

Apart from a touch of arrogance, the piece also reveals a poor grasp of how investing works. Investing is a personalised activity i.e. each investor pursues an investment philosophy and strategy that works for him. This principle holds good for portfolio managers as well.

For instance, while some managers pay more attention to top-down factors, others rely on bottom-up analysis. Some invest with a growth-bias, while others have a value-bias. There are managers plying research-oriented strategies and others who deploy a sentiment and momentum-driven approach. Even the investment horizon can vary significantly. Admittedly some strategies are more efficient than others, but that doesn’t take away from the fact that investing isn’t a one-size-fits-all activity, as the article erroneously suggests.

Equity investing isn’t a pure science. When a manager evaluates a business, factors such as his investment philosophy, interpretation and biases (among others) come into play. To suggest that every manager should have (or did) read the macroeconomic environment in a uniform manner is oversimplification. More importantly, is it apt to evaluate managers based on one event? Prudence demands that an equity manager be evaluated over the long-haul spanning a market cycle.

An element of bragging rights is perceptible too. Over the last year or so, equity markets have experienced a fair bit of volatility. The flagship equity fund (from the author’s AMC) takes cash calls based on valuations, and has expectedly fared well in a peer-relative sense. The portfolio manager and strategy deserve credit for the showing. However, that doesn’t diminish the credibility of competing managers who don’t take cash calls; expectedly, such funds have fared poorly in the recent past.

   

On the dishonesty bit, yet again the author displays his ignorance by mixing up the roles of an adviser and a portfolio manager. The latter is responsible for running the fund to the best of his abilities and in the investor’s interest at all times. However, offering the investor asset allocation-related advice, or managing the investor’s portfolio is not the manager’s role. That’s what advisers are engaged for.

In the competitive asset management industry, the need to celebrate and spread the word about one’s success is understandable. However, branding the competition as stupid and dishonest on untenable grounds reeks of ignorance.

Why Indian Fund Companies Shouldn’t Fear Greater Transparency

Media reports suggest that several Indian fund companies are at loggerheads with market regulator SEBI. The latter wants to increase transparency by disclosing commissions paid to distributors in investors’ statements of accounts. On the other hand, fund companies believe that doing so will be detrimental to their interests. According to reports, industry body AMFI has communicated its reservations to the regulator.

Reasons for opposing the move are varied: some fund companies think disclosing commission-related information will dissuade investors. Others feel that bombarding investors with too much information will be detrimental. 

To my mind, the concerns raised by fund companies are both misplaced and weak. To begin with, the proposal doesn’t alter the working of the fund industry in any manner. Fund companies pay commissions to distributors for selling their products (and rightly so!); all they need to do is disclose the same to investors (who bear the cost). No one’s suggesting that fund companies should stop compensating distributors.

As for fears of investors becoming upset by learning about commission payments, or becoming confused on account of too much information—those are weak arguments. Fund companies would do well not to underestimate the investor’s intellect. To assume that an investor who is satisfied with his investment will turn his back on it, because the agent’s commission is disclosed is a fallacious argument.

When an investor invests in a mutual fund, effectively he engages a fund company to manage his monies. The fund company charges a TER (comprising everything from operational expenses, the fund company’s fees, to the distributor’s commission) for the service. An unambiguous disclosure will aid investors better understand the fund’s working, and thereby make informed investment decisions.

For instance, a fund company which keeps costs (including fees and commissions) low and thereby enhances the fund's returns can benefit by communicating the same to investors. It can be safely stated that such disclosures will go a long way in winning investors’ patronage.  Conversely, the investor has a right to know if his fund is losing its competitive edge on account of exorbitant commission pay-outs.

Case for more disclosures

I’m surprised that in its quest for greater transparency, SEBI didn’t start at the top of the pyramid i.e. with fund companies. There is a strong case for making public, information related to the fund company’s compensation policy for its investment staff (portfolio managers and analysts), and also information regarding a portfolio manager’s personal investments in funds he runs.

Taken together, the two can reveal a lot about the fund company’s culture, its attitude towards investors, and a manager’s commitment to his fund—all of which can be vital in helping investors make better decisions. 

Admittedly, from the perspective of fund companies, revealing information that hitherto was private can be discomforting. But it is in their interest to embrace this change. Greater transparency isn’t an end in itself. The intent is to improve investors’ investment experience, and in turn make mutual funds more appealing. And when the investor wins, so will fund companies.

Investment Lessons from Yuvraj Singh’s T20 Innings

On Sunday, I watched the third T20I between India and Australia. Chasing a stiff target of 198 runs, India seemed on course until the third wicket fell. The next batsman Yuvraj Singh, was making a comeback to the national team. In the initial part of his innings, Yuvraj struggled, scoring just five runs in nine balls. As the required run-rate rose, the buzz on social media and the views of television commentators weren’t particularly charitable.

Then something interesting happened with India needing 17 runs to win in the last over. 11 runs were scored from the first three deliveries which Yuvraj faced – including a four and a six – putting the run chase back on track. With India winning the match, Yuvraj was hailed as a 'hero' all over.   

To my mind, the reaction was a classic case of circular logic; in other words, the result was used to selectively determine the cause. I have no doubt that had India lost, the focus would have been on the first half of Yuvraj’s inning wherein he struggled; furthermore, he would have been painted as the villain of the piece. However a win meant that the focus shifted to his impressive performance in the last over.  

Now let’s draw a parallel with the world of investments. Investors often rely solely on the performance to draw an inference about an investment avenue’s worthiness. For instance, if a mutual fund clocks a strong showing, investors infer that the portfolio manager must be skilled, the investment process must be robust, and so on. However such ‘analysis’ is fundamentally flawed. 

To begin with, in a rational approach, one or more causes lead to a given result, and not vice versa. Also, the performance-based approach fails to separate luck from skill. Consider, a mediocre fund helmed by an incompetent portfolio manager who got lucky with his stock picks. On account of the positive performance, the manager will be considered to be skilled. Likewise, a skilled manager whose investment style is currently out of favour will be given the thumbs-down on account of a poor showing. Investors’ woes will be further worsened if they choose to focus on near-term performance in an asset class like equity. 

A prudent approach would be to identify and evaluate factors that will influence performance. The results of this evaluation must then be compared with the fund’s long-term performance. If the two are in sync, then the analysis can be considered to be accurate.

Market-linked investing is inherently risky. Investors who base their decisions on performance, further accentuate the risk borne. While adopting this approach in cricket-related matters is harmless, doing so while investing could be a recipe for undesirable results.

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

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.