Paying Advisor to Buy Blue Chip Shares

Twitter is a place where you meet Strangers. Some become friends for life, some acquaintances but most just some one whose tweet you once read and either agreed or disagreed. While Twitter is known for its Trolls and abusive behaviors thanks to the cover of Anonymity, there are people who are kind beyond what you feel you yourself deserve. For me, one such guy has been Muthukrishnan. I haven’t met him or even talked to him on the phone, barely retweet his tweets and have once in a while disagreed to. Yet, for some reason he showers more kindness than I receive from people I know better.

I don’t disagree on his overall philosophy though once in a way I do disagree. His view on buying stocks for dividend for instance. I have my reasons, he has his. A key question he is asking these days is – Should you pay a fund manager a % fee or worse a profit sharing fee to buy and hold Blue Chip Shares. He believes that fees eat into returns and hence one should not.

I agree with his view that fees eat into returns. But that is not the entire story and here is my view on why it may not be wrong to pay a good advisor to buy and hold great shares.

Vanguard US has a very nice graphic that shows that if you pay 2.0% per year over 25 years it would wipe out almost 40% of your final account value. If you have invested in a regular mutual fund, 2% is what you are charged. So, the number is not a huge assumption vs the reality.

The delicate question though is – Should you pay a manager to Buy and Hold Blue Chip shares. Now, this is not a strategy I know that is followed by most funds and here I mean PMS since Mutual Funds like it or not are measured against bluechip returns and hence forced to buy the very same bluechip stocks.

The flexibility SEBI allows PMS on the other hand is very huge when you compare versus a Mutual Fund Manage. From Large Cap to Micro Cap, he can invest anywhere. He can go to Cash for 100% of the portfolio value if he deems it necessary. Only thing he cannot do is take leverage – but an AIF fund manager can do even that.

Before we tackle PMS, let’s get the pesky Mutual Funds out of the way. Large Cap funds haven’t been able to beat the benchmark Indices for a long time now. With Reliance now being the biggest jockey, it can become even more pronounced as Mutual Funds are limited to holding not more than 10% of their Equity in one company while the weight of Reliance in the Index they track has moved well past that number.

Large Cap Mutual Funds are now called Closet Index Fund. From the web, a Closet Index Fund is defined as 

A closet index fund is an actively managed mutual fund whose portfolio includes many of the securities in its benchmark index but whose expense ratio is higher than that of a true index fund or exchange traded fund (ETF) tracking the same index.

A simple ETF is available at 0.10% fee or lower. So, why the hell are people paying 2% (or even more in some cases). Are these guys really stupid? And we are not talking about a few folks either – Almost 81% of investors, that is 4 out of 5 investors come through the Regular route and hence are paying upwards of 2% as fees for having their funds managed by the Mutual Fund Companies.

With Indian Economy and Industry going nowhere, returns are pathetic and yet, the surge in assets we saw in 2014 is not going to topple over easily. So, why are investors staying despite pathetic returns that could have been achieved by safer methods and more importantly paying a 2% fee for the pleasure.

To understand that, we need to take a look at the bigger picture. While the Mutual Fund Industry has grown tremendously, it’s still small when you look at the “ Composition of Household Financial Assets”. As of June 2020, RBI estimates it at around 7%. This is the percentage of financial assets which ignores assets such as Real Estate and Gold.

That is 7% financial savings of Individuals are getting routed to the markets. This is fairly low but not surprising owing to not only lack of knowledge but also lack of safety net in India which means Individuals prefer safety of capital over its growth.

As someone who has been in the Industry for a long time, it’s not surprising that Industry veterans find it surprising that there are folks who are paying for non-performance so as to say. But what they are missing is the fact that most of the clients don’t have the financial knowledge required to handle their own monies. 

The Internet has democratized learning but you don’t self-medicate (other than maybe Crocin or body pain tablets) just because you have read on the Net and understood what is ailing you. While not exactly comparable, for many they feel better off with someone – even if that someone is not really an expert himself but paints as one rather than take the risk himself.

The fear for most is losing money. It’s that fear that drives most to trust someone who they think will handle the money better than they can handle themselves. This fear is not about being paranoid either – whenever markets crash, even non business papers write in big bold fonts the thousands of Crores that has been lost by investors in a single day. This is a meaningless number, but who is to inform them of this.

The alternative path that most of these investors will choose without the ability to invest through an advisor is to invest in a Fixed Deposit. In fact, I am pretty sure that a lot of Investors who go to the Bank – a private sector bank to be more specific would have had the idea of investing in a Fixed deposit but were shown a different way to save and invested (hopefully since Banks are notorious for selling ULIP) in a Mutual Fund.

Markets have had a crappy time for a long time and regardless of what the Experts say, it’s unlikely to change in the coming quarters either. Yes, the darkest before dawn but the light at the end of the tunnel could also be the headlights of the incoming railway engine and not the end of the tunnel itself. 

Either way, while investors seem to be getting a raw deal, the other options available to them aren’t any better either – invest in FD at a taxable rate of 5.5%?

Okay, I understand why small investors may be okay with high fees and pathetic performance, but what about HNI’s you may ask – Why are HNI’s willing to pay a fund (PMS generally) a fee for just buying and holding a set of high quality stocks.

While most PMS don’t buy and hold, I do know of a PMS that has a AUM of greater than 2000 Crores and buys and holds a portfolio of quality stocks. In the few years of data I could get access to, the client saw barely any change other than one stock being added after its Initial Public Offer.

The said fund charges no fixed fee but a performance fee over a hurdle that can be crossed even in these days by a liquid fund. Yet, the AUM keeps growing. What explains such incongruence. After all, here we are talking about sophisticated investors who can easily replicate what the fund is doing and save themselves a bundle. Why are they not doing it when it seems so easy?

In mid-2016, Saurabh Mukherjea came out with his book – “The Unusual Billionaires” where he showed how buying and holding a set of quality stocks over 10 years would have beaten most other funds not to mention the Indices. There was even a Interview where he listed out the stocks that currently matched the requirements (Link).

I used that list to create a portfolio (my own weighting method) and posted it on Twitter too. 

Coffee Cup Portfolio, some tit bits of data 🙂 pic.twitter.com/83eDdxWB1K

— Prashanth (@Prashanth_Krish) November 19, 2016

I bought and have been holding the same. A few months from now, it will be 4 years since I did that exercise. The portfolio itself is up 60% vs 42% by Nifty 100 which I took as the benchmark. No trades, No Fees, None whatsoever over the last 4 years – not tough, ain’t it?

The reason I have been able to hold is not only because I understand better but also because today it comprises just 10% of the equity portfolio. What if this was 50%, would I have been able to stay on?

Identifying Blue Chip stocks of today is easy – the problem is what will you do once they are no longer a blue-chip. An Index automatically chews over a stock that has lost its game and adds a new entrant, same goes for a fund manager who will chuck out a stock and buy what he believes is better instead. Stocks once considered blue chips and even many which were part of the Index today lie in ruin. Buying and Holding them would have meant not just an opportunity cost but also a real cost in terms of loss of capital.

By paying an advisor to buy and hold, many clients are basically outsourcing the pain component that involves selling the bad apples and buying new apples that appear suspicious today but in the end may actually deliver the goods.

Can this fee be lower? Of course, it could be – but like the Brokerage industry of the past, until a challenger emerges, why cut your own income. So runs the gravy train.

Personally I believe that funds that buy and hold good quality stocks and churn very little are doing a great service for while they may not get interviewed on Television every other day, the clients are assured of safety of capital. 

Measuring returns based on what they could have achieved by buy and hold of the same is factitious since we can never be sure if they would have bought and held the same stocks or rather just used the money to buy a vacation apartment as an investment.