Do Indian business group owned Mutual Funds maximize value for their investors?

One always wonders how India’s Business groups perform in their finance ventures? Do we see conflicts of interest as in funds are channeled to the groups from their finance entities?

In this paper, IIMB Professors look at this problem albeit from a different angle. The paper is written by – Profs. Pulak Ghosh, Jayant R Kale and Venkatesh Panchapagesan. They see how mutual funds operated by these business houses perform:

The manager of an Indian business group (BG) fund can have access to private information on its own BG firms and their industries. However, since the fund belongs to a BG, the fund manager may also have incentives to undertake investments that benefit the BG firm managers and not its fund investors. In this paper, we examine the relation between a business group (BG) mutual fund’s return performance and its ownership levels in (i) its own BG firms, and in (ii) the rivals of its BG firms that operate in the same industries. Using return and portfolio holdings data on a survivorship-bias free sample of Indian BG mutual funds for the period 2002 – 2010 we find that the relation between a BG fund’s risk-adjusted returns and its ownership in its own BG firms or firms in BG industries is roughly in the form of an inverted “V,” i.e., funds underperform whenever they increase or decrease their investment in group firms or rival firms beyond what a typical fund invests in these firms. The effect is stronger for underinvestment. This finding for BG firms suggests opportunistic behavior on the part of the BG fund manager.

Hmmm…So whichever way the BG owned MFs underperform.. whether they increase or decrease their investments in BG owned group companies. Why should this be?

Since funds underperform when underinvest in their group firm stocks or their rival stocks, it must be the case that these stocks must be performing better than expectations and are underrepresented in the BG funds’ portfolios. To determine whether this is indeed the case, we examine the performance of BG firm stocks and their rivals when BG funds underinvest or overinvest in them. We take all BG firm stocks (and rivals) and group them into tertiles based on the degree of excess investment by BG funds: Low excess investment (characterized by high under investment), Medium and High excess investment (characterized by high over investment). We then compute the average and median monthly return of stocks in each tertile to see whether stocks that have greater underinvestment indeed perform significantly better. We use the excess return over the BSE 500 index to determine the stock’s performance. Table 7 reports these results and as expected, stocks that are underinvested by BG funds tend to perform better than stocks that have been overinvested. Clearly this suggests that BG funds are leaving money on the table by choosing to underinvest compared to their peers.

There are plenty of tables and data in the paper. Need to read more in details..

 

 

 

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