Mutual Fund | Portfolio Yoga

When Risk Comes Calling

I started my career as a Fixed Deposit agent canvassing Fixed Deposits for Non Banking Financial companies. Given that I was really young and not really educated formally in the field of finance, I was barely able to convince potential customers of depositing their hard earned money in the companies, many of which they hadn’t heard about. That left me with my only trusting client whose money I managed to invest – my Grandmother’s.

While lack of formal education or experience was a negativity and I really didn’t fully understand the value of money at that point of time, I did understand one thing – invest in only firms that have a AAA rating.

I had zero clue about how that rating came about it other than the fact that it signified the company was a good one to invest in. I avoided investing in even companies with AA rating other than for one investment I got my grandmother to invest into which was a subsidiary of Apple Finance (which had a AAA rating) – Apple Credit Corporation. The reason for investing in a AA company was simple – higher interest rate. ACCL offered a Cumulative Deposit with 21.5% interest payable on maturity.

But the investment in itself was small – a kind of take advantage without having to really worry if the risk came home. Thankfully none of the FD’s I had my grandmother invest ever defaulted – maybe more to do with Luck than Skill, but it still felt like an accomplishment at that point of time.

The Indian Express today had an article which puts the total amount of bad loans written off by Public Sector Banks at 5,55,603 during the period when the current Prime Minister, Narendra Modi has been in Office. While it’s easy to jump to the conclusion that much if not all of the bad debts is because of the government, the real facts aren’t and will never be so straight forward.

Banks are in the business of giving out loans and not all loans despite most backed by some sort of collateral come good. But thanks to the fact that Banks are able to borrow cheap and lend at a substantially higher level, Banks are able to make money post the write off’s. HDFC Bank for instance has a cost of deposit at 4.82% vs average yield of 9.22 leading to a Net Interest Margin of 4.4%.

Banks understand Risks and even in the worst instance, there are back-up’s that ensure that the small investor’s money is never at risk. After banks, the largest lenders are Non Banking Financial Companies. Once again, they make money by ensuing that they have a difference that can take care of any bad loans that shall accrue during the course of their business.

In recent times, Mutual Funds which are flow throw vehicles have come to become on the largest lenders – and sometimes the lender of the last resort. In March 1999, India had 44 Income Schemes which in total managed 1848 Crores. This was 15% of total amount mobilized by Mutual Funds across all Schemes – Debt and Equity.

By April of 2009, total number of Income funds exceeded 500 while total assets under management had moved to 1.97 Lakh Crore. This was 47% of total amount mobilized by Mutual Funds across all Schemes – Debt and Equity.

Come 2019, and we today have 1250+ funds with total assets of 7.20 Lakh Crore. Percentage of Income funds as part of total assets declined to 30% as the percentage of equity funds have advanced strongly in the last decade (from 23% to 32% – 2009 vs 2019).

Since numbers without relative context don’t provide a real understanding, how about comparing to a real large bank. Bank of Baroda is India’s second largest public sector bank and it had at end of 20018 advanced 4.27 Lakh Crore.

Growth of Assets always has a price that needs to be paid. Small Cap fund managers for instance will either need to shut the inflows or move to Mid Cap stocks once the assets they manage start to move higher than what can be possibly deployed with manageable risk in Small Cap stocks.

Debt Fund Managers have for a while been facing a similar problem. How to deploy the large amount of money that was being mobilized while still ensuing that the risk was contained. The easiest was to deploy would be to buy Government Securities. That assures zero risk of capital loss but comes at a lower yield and if the fund wants its own pound of flesh, it makes the fund unattractive to Investors whom it wants to pitch for investment.

The riskier the investment seems to be, the higher the interest rates are. While State Bank of India can mobilize Fixed Deposits at less than 7%, a Cooperative Bank such as Mahaveer Bank offers 8.50% for a similar tenure.

Similarly, the way mutual funds are able to attract more assets under their management is by generating a higher return which in-turn asks for higher risks to be taken. The key difference between a Bank that takes similar risks to a Mutual Fund is that the Mutual Fund is like my Grandmother – I am taking risks on “behalf” of her. If a company defaults, I being the middle man have no way of compensating her.

Yet, in the quest for returns, Funds have taken fool hardy risks and for a while this seemed like the way to do business. Funds suffered literally zero defaults as ample and easy finance by Banks ensured that even the most tyrant promoter paid up his dues on Bonds the funds have bought.

The first sign of change was when companies that had kept rolling their bonds thanks to the unlimited tap given out by Public Sector Banks defaulted. The reason for the default basically lay in the change that RBI mandated Banks to make which mean that ever-greening was a thing of the past.

Yet, the caravan continued to roll on as Fund Managers (save for a few) were able to avoid that hurdle and it was back to business as usual. The more massive hit came from an unexpected source – IL&FS.

When IL&FS bombed out, it hurt not only itself but a lot of companies that had got used to raising cheap finance by selling short term bonds – many secured by nothing more than their bubbly shares. This today is what the drama around the Fixed Maturity Plans and tomorrow could be of many other plans as well.

Take for example, Adani Infra (India) has raised funds by selling its Bonds to Mutual Funds (Kotak Fixed Maturity Plan – Series 186 for instance has 10% of its assets). Bonds of this company are rated AA. In its Rating Rationale, Brickworks says this,

“The rating factors, inter alia, the strength of underlying security in the form of pledge of listed equity shares of APSEZ and ATL with the current promoter pledge of 35.5% and 44.7%,respectively, structure of the NCD, resourcefulness of the promoters of the Company, and financial flexibility of the group.”

The basic rationale behind the rating is the pledge of shares. But what use are shares if you cannot sell them in the markets without depressing the stock to an extent that rather than the borrower being hostage to the lender, it becomes the other way as we are seeing in case of Zee and what we will see in many over leveraged and over extended companies in the months and years to come.

Mutual Funds aren’t Banks, Period. The blame also falls squarely on the government which through its taxation policy has ensure that small investors pay a much lower tax on gains from Mutual Funds versus monies deposited in Banks.

This has distorted how people invest and has let investors take risks higher than what they knew them to be. Debt funds losing money due to bad calls isn’t atrocious as it may sound – it’s the way they have been sold (as alternative to fixed deposits) that is the root of the problem.

But till the time the government wakes up to the distortion, the best way is to invest in funds that are large (preferably the largest around) in the space of Liquid, Ultra Short Term and Low Duration. If you want to be really safe, get into Liquid funds like Quantum which have a portfolio of only GSec’s and Government held Entities. But the yields are lower as should be the way.

Stay away from anything that is closed (Fixed Maturity Plans) unless it’s a small investment and the Indicative Yield seems attractive enough to take such risks.

In my opinion, it’s a fruitless venture for most to chase Alpha in Debt. You are paid way better in Equity where the upsides of being right can be monstrous versus just getting paid interest and principal on time.

Paytm will make investing in Mutual Funds easier, but is it setting up new investors for disappointment

While investing directly in a mutual fund was offered more than 5 years ago, it was a child that no one wanted. Asset Management Companies offered it just to ensure compliance with the rules rather than see it as a way for individual investors to avoid the middle man.

While even today, Mutual Funds are easier to access than say an Exchange Traded Fund, investing in Direct funds wasn’t something that was easy. Yes, we did see new fintech companies come up with a flat fee based subscription, but if you were good with technology, you anyways could have easily bought the same from the mutual fund house website directly.

The first real attempt to reach out to normal mom and pop clients out there was to me enabled by the launch of Zerodha Coin. By providing the ability to buy direct funds through the brokerage interface, it made life much simpler than it was earlier.

Last week, Paytm launched its own offering – Paytm Money which allows anyone with a Paytm account to seamlessly buy mutual funds from its app. With growing usage of smartphones, this can trigger growth like no other.

In fact, Paytm expects to see more than 1.5 Crore investors using its app to invest in mutual funds. Nilesh Shah, managing director, Kotak Asset Management has gone to record to say that he expects Paytm to double the number of investors in a couple of years.

Over the last few years, money has flown into mutual funds like they never had seen earlier. Strong advertising has ensured that even those who may not have been inclined to invest in mutual funds at least have a understanding of what it means.

Ease of buying can always trigger irrationality like no other. The simple way you can buy on Amazon for example means that many of their customers end up buying far more than what they desired to buy or were required to buy in the first place.

Unlike in United States where interest rates are so low that equity makes sense for almost all categories of investors, in India, Interest rates is pretty high and doesn’t really require a massive dose of equity exposure to help you reach your targets.

But Debt funds, especially short term funds where no prediction of the Interest rate cycle needs to be made has always seen fees that are barely there. Mutual Funds are more than happy to sell Equity as the panacea to all ills given that even Direct funds charge on an average 1.5% to manage your money.

The huge inflow of funds in such a short span of time in a market that is not really deep has meant that mutual funds continue to chase the same set of stocks regardless of whether it makes sense or not.

So, we have Tyre companies which historically used to trade at single digit or low double digit valuations now trade twice their historical mean.

We have Fast Moving Consumer Goods companies which can at best growth at a bit higher than GDP + Inflation; selling at valuations that many a stock saw during their peaks in earlier mania’s.

Page Industries, the leader in the premium undergarment segment trade at triple digit valuations even though its unlikely the company can deliver that kind of growth even if everyone is made to buy 2 pairs – one for the morning and one for the evening.

The biggest physical retailer in the world – Walmart for a very long time traded at low valuations below the 20 times earnings. Our biggest listed retailer on the other hand trades at a price to earning ratio greater than 100. While for now, its growth is able to provide some semblance for the valuation, can retailers really grow at 100% or even 60 – 80% as the market expects it to for a long time to come?

Literally everything out there in the market seems expensive and the continuing inflow of funds have meant that they have either stayed expensive till our brains got fried and we joined the herd or have become even more expensive making anyone who used valuation as a measure to justify investing look inept.

The other day, I was at Karvy for some work regarding transfer of securities and happened to overhear the conversation of a couple who had come there to redeem their mutual funds. They seemed unhappy that even though they had been invested for some time, they barely got the returns they expected (or assumed).

The last 10 years has been incredible for funds given the fact that starting point is now closer to the bottom we made in 2008. This seems to suggest that investing for the long run can be very fruitful indeed.

But ten years ago, markets were pricing in more for bankruptcy than for growth. Today, markets are pricing in anticipating that India will grow at record pace. The key reason for such exuberance has to be seen in the light of the fact that while inflow of funds into the markets has shot up big time, the number of investments that are available haven’t.

Abnormally high valuation is clearly not sustainable in the long term. If zero risk debt assets can get you 8% and low risk debt assets can get you close to 10%, the expectation of returns from risky assets such as Equity tends to be much higher and that itself can be a source of disappointment.

Among Large Cap funds, Nifty 100 Total Returns Index has given a return of 12.50% over the last 10 years. The category average return was 11.23%. The last 10 years has been one hell of a bull market in hindsight, will the next 10 years pan out similarly?

The category average return for Ultra Short Duration funds over the last 10 years has been 8%. This means that equities have generated 3.25% more returns which is substantial but one that required a lot of things to come together.

While my recent posts seem bearish in nature, I am not really bearish when it comes to investing with close to 50% of my assets sitting in equity. But my expectations are tempered given the historical experiences I have had.

New investors on the other hand attracted by fancy returns generated by funds in recent past will turn out to be disappointed even though the returns maybe comparable to what should be expected going forward.

For anyone who entered real estate before it became the hot subject of town, returns have been fairly good even though markets have stagnated in last few years. Those who looked at short historical returns and ventured into real estate though have been a disappointed lot owing to setting themselves to wrong expectations.

More new investors I expect will end up having a disappointing experience in equities unless their expectations are tempered to begin with. But in the never ending race to gather assets, who is really looking to bell the cat.

Fee always makes a difference to the outcome. Stop following the Herd

Till the establishment of the National Stock Exchange, anyone who wanted to buy shares approached brokers of the Regional Stock Exchanges who either bought the shares on their own exchange if it was traded or bought it on another exchange on which the stock got traded.

There were two kinds of fees that brokers levied. One was the brokerage which was anywhere between 3 to 5 percent of the transaction amount depending upon whether the stock was traded at the exchange where the broker was a member or on another exchange.

Of course, this was the known fees that were paid by the client. The unknown fees were that of the difference in price between where the share was originally bought or sold and the price reported to the client.

It was not a surprise that Regional exchange membership commanded mind-boggling prices. Most exchanges gave out a limited number of membership cards. The scarcity of the membership card combined with the opportunity to make a bundle meant that come rain or shine, prices of the membership card barely went down.

To compensate for the high fees, each member was allowed to bring in a few more authorized assistants into the trading ring. Even at exchanges where volumes weren’t really great, the price for becoming an authorized assistant wasn’t cheap.

Time and Tide wait for none and so it has been for the stock brokers. First came SEBI which restricted maximum charge that a broker could levy at 2.5%. Establishment of the National Stock Exchange was the real deal breaker when it came to membership prices. Operating on basis of Deposits only, NSE literally pulled the rug from under the feet of other stock exchanges.

Brokerage rates have been on a downward trend since then though establishment of Zerodha in 2010 with its per trade brokerage at first and later going in for free brokerage for delivery trades. Incidentally, the US seems to be catching the same bug with JP Morgan following the lead of Robinhood in offering free brokerage.

The key reason for falling brokerage was not because of the SEBI law which still held brokers could charge 2.5% but because National Stock Exchange removed once and for all the arbitrage held by brokers. Since becoming a broker was now easy and much of the deposit was refundable. Demand and Supply leveled the playing field once and for all.

Few days back, all hell broke through when Morning Star released its Morning Star Global Fund Investor Experience Report 2017.

India has a very good score in many aspects. 100% of mutual funds in India revealed their portfolio’s on a monthly basis, something that no other country in the list comes close. Indian Mutual funds also have the lowest time lag from end of month to release of portfolio holding details at 11 days. The worst is Hong Kong at 113 days.

The key reason for the anger lay in the section of Fee and Expenses. India saw a drop from its previous standing to now be part of the Below Average category. While Fees are indeed higher compared to other countries, Front Load not being present should have added value for they too are a part of the Expense Ratio, at least for the First year of investment.

Its thanks to SEBI in large part that today we are able to enjoy a low brokerage structure that is absent in most other countries. But it’s the same SEBI that seems to be the hurdle when it comes to opening up of the financial sector for competition.

While RBI restricts Banking Licenses making it nearly impossible to compete with existing banks, SEBI by way of minimum capital requirement has made it tough for competition to emerge.

In 2014, SEBI raised the Networth required to become a Mutual Fund from 10 Crores to 50 Crores. In one step, SEBI killed the competition that could have come up with interesting and new products. Over the last few years, we have actually seen a decline in the number of fund houses as small and non-viable firms looked for an exit.

Take for example, the United States where anyone can set up a Mutual Fund with Setup costs typically between $75,000 to $100,000. At the higher end, this is more or less 2x the Per Capita Income (PPP).

Indians are flocking to mutual funds like never before. The key reason is not just the strong advertising that showcases the advantages but the fact that the alternative asset classes was not delivering the goods.

Interest rates had fallen and with it being taxed at bracket levels, Fixed Deposits was not seen as appetizing. Real Estate which long had been and continues to draw investors hit a wall as after years of galloping returns, prices have more or less flattened.

During these times, Equity markets rose like a phoenix and rewarded those who were invested handsomely.

But asset classes don’t always move in a single direction. Equity markets have been going up like there is no tomorrow (these days, its mostly limited to large cap), the earnings which are not rising in the same breadth means that sooner or later, this rally too will fizzle out.

While bear markets are part and parcel of any stock market, paying excess fee can mean that your own returns are sub-optimal even though you may have had the knowledge that many others don’t when it comes to investing in equity.

With no new fund houses on the anvil, active funds in India have the upper hand. But that doesn’t mean that one has to pay through the nose for there are many a simple alternatives – Exchange Traded Funds (ETF’s) and Index funds which while not promoted can in the long term provide you similar returns thanks to their lower fee structure.

While an investor who is clueless about the world of finance may be easy to be misled, why are you, a person who knows better following the herd?

A deeper look at Liquid Funds

Equity Analysis they say is complicated and yet I find Debt to be more complicated than Equity. Maybe this has more to do with the fact that much of my experience in finance markets has been with Equity compared to Debt.

In Equity Markets, I believe in applying my skillsets using Quantitative methods than Qualitative which can lead to Bias. In Debt, doing the same led me to errors that were realized when people who eat, breathe, and sleep debt pointed out that analysing Debt the way I was doing was error prone.

For much of the older generation, Debt meant one thing – Fixed Deposits at Bank and Post Office. Over time though, Debt Mutual Funds have come with options to invest in a wider variety of instruments – from short term Commercial paper to Long Term Government Treasury Bonds.

Trying to understand Debt from the same lens as Equity is futile. Equity, especially once you eliminate low liquid stocks, can be compared against one another using methods such as Sharpe. Sharpe ratio penalizes for Volatility and this is a good framework when tackling stocks where all other things being equal, you would want to buy a low volatile stock versus a high volatile stock.

The same in Debt would lead to wrong results. An illiquid low quality bond may not trade as much as a liquid high quality bond resulting in Sharpe being higher for the fund that holds the low quality versus the other fund.

With nearly 42% of total assets under management in Debt funds being in the Liquid category, this static alone makes it very important to understand it’s working. Add Ultra Short Term and Short Term to this, and we have 80% of the total market out there.

Fixed Deposits are the deposits of choice for vast majority of investors. But over time, the way Interest on Fixed Deposits is taxed compared to Debt funds have made them unattractive other than for Senior Citizens whose Income may not come into the tax bracket.

A secondary risk is in terms of locking of Interest Rates. Currently SBI pays an Interest of 6.50% on Fixed Deposits with term of 2 years or greater.

While this may be good in times of falling interest rates, this lock in can yield sub-optimal returns. For Corporates who have large cash flows, the differential is even bigger since Current Accounts pay nothing. Just investing for the weekend can for many of them provide enough returns to make the task worthwhile.

So, how does one go about Analysing funds?

Investor’s key reason for being fixed on Fixed Deposits is the Risk of default. Most are happy with lower returns than take the risk of default that can wipe out a permanent capital.

On 22^nd February 2017, Taurus Mutual fund’s Taurus Liquid Fund dropped a massive 7.2%. The reason for such a large drop was the Default in Bonds of Ballarpur Industries.

To understand how large that drop was, it was enough to wipe out One year of Gains. Anyone who invested in the fund just before the incident would have seen his fund value come back to square one nearly one year after the said incident.

In September 2015, JP Morgan, a biggie in the world of Fund Management had its own fiasco as exposure to Amtek Auto led to two of its funds taking a hit on the NAV.

Liquid Funds which invest in securities with maturity less than 91 days are seen as equivalent to cash – ultra safe. While Taurus fund showcased the risks of even Liquid funds, such instances have been rare and far in between.

For fund houses that manage large corpus of funds, any such default is a death knell since it tarnishes the trust that is required. JP Morgan for instance bowed out of the Mutual Fund business shortly thereafter selling it to Edelweiss.

As Warren Buffett once said,

“It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you’ll do things differently.”

So, how does one go about Analysing funds in the Short Term to Liquid Fund stable?

Looking under the Hood – The Portfolio:

The key to understanding the Risk taken by a fund is by diving deep into the portfolio it owns. It’s not an easy exercise either as lot of firms borrow using the subsidiary route.

The above chart is the Sector Holding Chart of Aditya Birla Sun Life Cash Plus, the largest fund liquid fund in India. The fund holds 171 different securities and while a cursory look seems to indicate no surprising entries, it’s really requires time and effort for a retail investor to really understand whether there are any unkind surprises lying out there.

Now, let’s look at a fund I like (Disclaimer: I have no financial interest in Quantum) Quantum.

While it’s true that this fund size is a miniscule of the bigger one, this is much easier to understand. The only risk out here is Sovereign.

When it comes to Risk, Generally smaller firms are willing to take a larger risk versus large firms which wish to stay away from unnecessary risks. In the field of finance, one’s ability to draw assets lie from performance and how can one perform without taking a bit more risks that can pump up the overall returns.

A 2012 study by Marcin Kacperczyk & Philipp Schnabl of Leonard N. Stern School of Business, New York University came out with some interesting findings on

Funds had strong incentives to take on risk because fund inflows were highly responsive to fund returns.
Funds and other financial services took on less risk, consistent with their sponsors internalizing concerns over negative spillovers to the rest of their business in case of a run – Remember the JP Morgan Episode. One bad call and the fund essentially shut shop.
Funds sponsored by financial intermediaries with limited financial resources took on less risk, consistent with their sponsors having limited ability to stop potential runs – Quantum being too small a fund for example may be a reason for them not to take risks verus bigger funds which having the backing of their parents can take a bit higher risks.

If Portfolio Analysis and probable implications is not our cup of tea, what other data can help us chose the better fund?

Size of the Fund House:

Rare are the times when a big fund house decides to let a bad investment call impact investor returns in funds such as Liquid. JP Morgan proved an exception to that rule and paid the price. A Birla or DSP or Franklin on the other hand wouldn’t like to damage their credibility by allowing pass through of bad calls.

But that would also mean as Buffett wrote in his recent annual report,

“Charlie and I never will operate Berkshire in a manner that depends on the kindness of strangers—or even—that of friends”.

JP Morgan is one of the largest financial firms in the world and yet they decided to let the investors suck it up. In case there is a default by a large firm, how ready or willing would be the fund houses to take the losses on their books?

Return & Expense Ratios:

Should an investor aim for the highest return or the lowest cost?

As the President of a Large Fund House said

“Ideally, seeking alpha in liquid fund is a fools game as this category can’t generate alpha by design and mandate”

While Expense ratio is definitely something to be looked at, it cannot be looked at in a isolation. Bigger funds for instance can easily cross subsidize their products making some cheaper than the rest – all in an attempt to be the largest asset managers in town.

Amfi data reveals that Individual Investors comprise a very small part of the Assets under Management when it comes to Liquid Funds. It would been interesting if we knew the percentage of funds invested by Individuals in Liquid + Ultra Short Term + Short term funds since these not only makeup 80% of the Assets under Management but also aren’t as easily impacted by Interest Rate changes as longer duration funds (Medium Term / Income Funds, Gilt Funds, etc) are.

Large companies are able to ascertain risk and rewards on a granular level and constantly be in search for the better option, for the smaller investor, its better in my opinion to be safe than sorry. Unless you think you can decode compex portfolios, the simplest ones generally end up offering the highest peace of mind.

Do note, that you can always bump up returns by proper allocation between Debt and Equity than trying to squeeze the last rupee out of any fund.

Thanks to Yamini Sood and Kalpen Parekh who provided me with perspectives and context on how to analyse debt funds. Being an Equity person, understanding and learning about Debt from people who are in the business for decades is immensely helpful.

Predictive Value of Historical Returns in Mutual Funds

Social Media has been a great leveler of things. While getting opinions of a dozen people in real life can be tremendously tough, thanks to Social Media, you know have the opportunity to tap into the opinions of thousands by the mere click of a button.

Polls have always been used to understand and bring out the view of the crowd where the majority may not always be easily distinguishable. The risk though is one of sample size and the kind of people who are surveyed.

As Election Surveys / Polls have shown, it’s never about how many people you polled but the diversity among them that counts and the weights you give to factor in biases that this selective population may have brought about into the poll – knowingly or unknowingly.

A few months earlier, I ran a poll on Twitter (where else can you can get so easy a access to so many smart and sophisticated investors) regarding what drove them to invest in Mutual Funds. The vast majority was inclined to Returns.

Post that poll, I wrote a post Chasing Performance & Behavior Gap. Yesterday, I ran a poll which is kind of following up on that question. If return was a criterion for investing, what was the look-back period investor were most concerned about.

The Options were the same options you can get at ValueResearch since this is one of the biggest sites investors use when researching a fund. While you can also do a point to point comparison, it’s not really simple to measure funds across multiple periods and our brains I doubt are wired to take the “Road not Taken”.

The fact that it’s easy to now get data on what funds are the best performers doesn’t really translate to being better investors. From Survivor bias to Information bias, we fall pretty easily to a lot of biases when looking at data selectively. But given that our options are limited, what we see is what we use to make the choices we make.

Mutual Funds have been in the news like never before but that has also meant that choosing the next big fund is getting near impossible thanks to erosion of competitive advantages the funds enjoyed when they were small.

SEBI’s recent decision to have funds compare performance against Total Returns Index versus the Spot means that almost all funds have suddenly lost a percentage of two of their Alpha.

While advisors preen about how they choose funds taking into account a variety of factors – data seems to suggest that its finally historical returns that can make or break a fund. Of course, even there, funds which don’t pay as much commission as advisors do worse since they are rarely ever advised regardless of performance or other merits.

Take a look at this data chart for example. Among Large Cap funds, excluding Index Funds and ETF’s, AUM is highly concentrated in the top funds. But are current rankings indicative of the funds greatness over time or are they just a random variable that happened to be at the right time and right place?

The best fund among all Large Cap Fund over the last five years is “ICICI Prudential Value Discovery Fund” but as anyone who has spent any time in the area of Mutual Funds knows, this fund was a Mid Cap fund that has overtime graduated to Large cap and hence the results aren’t really comparable.

The Second best fund is Invesco India Growth Fund. But this fund wasn’t known as Invesco for a long time but was known as Lotus India Growth Fund. In 2008, Religare Mutual Fund acquired Lotus Mutual Fund and this fund became known as Religare India Growth Fund. In 2013, Invesco acquired 49% of Religare Asset Management and the fund was from then known as Religare Invesco India Growth Fund. In 2015, Invesco acquired the stake of Religare and the fund since then is known under its current name.

With Asset Under Management of around 300 Crores, this is one of the smaller funds among the large cap Universe. But if you are looking at performance, the AUM should be the least of the worry. A smaller AUM also provides the fund manager to be flexible compared to large AUM’s though there is no correlation between returns and assets under management.

If you were to just invest in the best fund over the last 5 years, you would have ended up with over 5 funds over the last 7 years, such has been the volatility among the top.

HDFC Top 200 fund which was the Best among Large Cap Funds is now a distant 18. SBI Bluechip fund which was ranked 31^st out of 38 funds in 2010 is now the 3^rd best fund with a huge asset under management to match the upgrade in ranks.

Predictive value of the data is based on how well the data has acted in the past and if the ranking of funds by returns over the last 5 years is anything to go by, this data has very less predictive value than most would assume.

Add to it the fact that 50% of the funds did not beat a simple benchmark like the Nifty 100 TRI, your ability to meet your goals based on assumed returns of these funds will leave a lot to be desired. While active management has worked in India, the odds of funds ability to beat their benchmarks is decreasing by the year. When expectations are set by the historical returns of some of these funds, you are setting up for failure and disappointment right away.

Let Data be your Guide to Investing, not Narrative.

Ruffling Feathers – the Ajit Dayal Interview

Most mutual fund distributors that I have come across online (I have been used to invested direct even before Direct was a option, so no offline distributor friends) rarely talk about a fund that has in its category been the best across 10 years and for good reason. This was a fund that until recently decided to ignore distributors, the champions of the Mutual Fund Industry and tried to touch base directly with the Investor.

For the trouble the investor took to invest on his own, the fund ensured that they charged the lowest fee (this before the onset of Direct) since no commissions needed to be paid to anyone.

The low fee structure has also meant a lower salary base for fund managers. While top fund managers of other funds earn Salaries of Crores (+ Stock Options which aren’t disclosed), the Salary of Atul Kumar, head of Equities at Quantum for instance is one of the lowest among Mutual Fund Managers with AUM > 500 Crores.

Last week fund investors received a letter bidding adieu from the founder, Ajit Dayal and suffice to say, other than those invested, don’t think anyone barely gave it a thought. But on September 1, ET published a Interview with him, where he called out the fund industry on the question of Integrity.

No one likes their Integrity questioned and least of all fund managers who believe they have done yeoman service to investors who have been able to get better returns even after paying a much heftier fee and in a way, they are right.

What Ajit Dayal set out to do when he started Quantum was similar in thought of what John Bogle tried with Vanguard or what Eon Musk is trying out with Tesla (Selling Direct to consumer to eliminate costs). As Robert Frost wrote in his splendid poem, “The Road not Taken”

I took the one less traveled by,
And that has made all the difference.

Quantum took a path that differed from what the rest of the Industry had taken. But taking a different road in itself doesn’t lead to success. To call those who didn’t take a similar path of dishonesty is asking for trouble. After all, unlike say Vanguard which has proven over time that Index Funds / ETF’s are the best instrument, Quantum hasn’t been able to sell as to why one should invest in its fund versus other funds which have given better returns post higher expense ratio’s.

A key reason given out by Quantum as to why it avoided Distributors is lack of transparency. But that could have easily solved by showcasing the commission that is given to the distributor as its now compulsory rather than eliminate the distributor completely.

Another class of people who are looked at with scorn are Stock Brokers .While there have been many Stock Brokers who have cheated their clients, not everyone is or was a cheat (Disclaimer: I am a Sub-Broker). Every Industry has its share of black sheep, but to call the entire herd black is stretching one’s own credibility.

Mutual funds on a whole manage around 6.3 Lakh Crores in Equity alone. Of this Quantum manages around 1000 Crores or 0.16%. Its way stretched to think that Industry could get here by just mis-selling to retail investors.

Mutual fund industry under pressure from SEBI started with Direct funds around 5 years back. Yet, the amount that comes through Direct is minuscule. The simplest explanation for this would be that the guys who are selling regular – Distributors / Financial Planners are providing some value which makes the end investor appreciate and willing to pay (in-directly of course) for the services rendered.

As I have written many a time, lower the fees, better the returns on the longer term. But if you have no clue about finance and aren’t willing to learn, it could turn out to be far cheaper to pay a advisor than try to do in oneself.

Quantum was a nice experiment and if they continue to adhere to their beliefs I do think they can make it big. Their Long Term Equity fund became the Best performing fund among Large Caps in October 2016, a position that they continue to hold.

Finally, its all about returns over the long term that matters. As long as the are able to achieve that, my money will prefer them over others. Ajit Dayal deserves praise for starting something different, yet he is as human and fallible as the rest of us. So, thank you Sir for the venture and Best of Luck for future endeavors.

Those who really deserve praise are the people who, while human enough to enjoy power, nevertheless pay more attention to justice than they are compelled to do by their situation. – Thucyclides

Read the full interview here: We have done all that we said we would do: Ajit Dayal

When founders Quit, does Philosophy change?

I have been a follower as well as investor in Quantum Mutual Fund and also a big admirer of their philosophy. While their fund, Quantum Long Term Equity was launched in 2006, unlike many, I came across them fairly recently (2012).

The key reason for me to like their fund was their philosophy of lower fees and willingness to go to cash when markets felt over-heated. While they remained one of the cheapest equity funds to invest for a long time, the same isn’t true now with mutual fund fees falling dramatically in recent times.

Yesterday, the man who started it all “Ajit Dayal” sent a letter bidding adieu to investors in the fund. This was very surprising given that founders do not generally exit the company without a period of transition and even then, generally tend to stay around for long to ensure continuity.

While returns are key, one of the reasons funds like Quantum have been able to garner assets is because of investors belief in the philosophy they claim to uphold. While Quantum sits on top of the ranking list (on ValueResarch) categorized as it is under Large Cap, that doesn’t really provide the true picture since just a few years back, it was categorized (based on their portfolio) as a Multi Cap Fund.

When a Star fund manager / founder exits the fund / firm, the key question that needs to be asked is, should one continue to stay with the fund. Most fund houses ensure that the logic / philosophy that is the core of the fund is ingrained that ensures continuity regardless of presence or not of the guys who build those philosophies in the first place.

As investors, when we invest in a fund, we are outsourcing the whole fund selection and investment process to some one we trust. The bigger the investment, greater the trust factor. But when key people quit without sufficient reason or warning, it puts us in a quandary about whether we should stay with those who remain at the firm or move.

Moves such as these reinforce my view that rather than be dependent on fund managers, one should develop the expertise necessary to invest directly in the markets. If that is not possible, the best alternative is to invest in Index Funds / Exchange Traded Funds.

The risk of investing in Index is that while we are basing our investment in a mutual fund on the capability of the fund manager in question, here we are trusting that the Index Selection process has a sound logic that can survive and thrive over time.

The key to returns is concentration and this is more so important in mutual funds where investing in too many funds will only mean fodder for everyone else while you get returns lower than what even the Index could have easily delivered. But when changes such as this happens, its time to step back and think deep and hard as to why you were invested in the fund in the first place and whether the logic continues to remain true – change of management not withstanding.

Personally, the family investments we have in Quantum will stay for now though I am not too enthused to invest afresh at this point of time.

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Looking under the Hood – The Portfolio:

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