Archive for the ‘Mutual Fund’ Category

How framing manipulations succeed in changing investor fund choices…A case of close ended mutual funds in India

April 10, 2012

A nice paper by  Santosh Anagol and Hoikwang Kim of Wharton.

The paper is based on SEBI’s regulation of distribution charges in  mutual funds industry. In 2008,  a SEBI policy   allowed close-end mutual funds to amortise the distribution charges over three years. However, for open ended funds only entry loads were allowed which was a one time charge. The policy was changed in 2010 with both close and open ended funds charging entry loads. (Open-ended funds are those where one can enter and exit from fund at any time. Close end funds allow to exit only after a selected period of time usually three years. In case one wants to exit penalties are severe.)

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Investing in Mumbai’s Politicians’ Fund…

September 16, 2011

I just wrote a while ago how investors keep being taken for a ride by active fund managers. This is common everywhere whether in India or US.

Now atleast we in India  have a solution. There is an ongoing study in economic department of Mumbai University – Unraveling corruption in India: Politicians in the spotlight. The study shows  Mumbai-based politicians make more returns than the city as a whole. The study is not out but you have some findings in HT:

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HDFC debt fund for cancer cure — mixing finance with philanthrophy

February 18, 2011

HDFC Mutual Fund, mutual fund company of HDFC fund has launched an interesting mutual fund product – HDFC debt fund for cancer cure. The product mixes finance/mutual fund management with philanthropy.

The scheme idea is:

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A guide to Mutual Fund Brochures

December 18, 2009

Finance Clipping Blog points to this very funny guide on understanding Mutual Fund brochures.

Fund Brochure Says… What It Really Means…
Ultra Leveraged to the Hilt
Global Growth We’ll Chase Stocks For You in Whichever Country is Most Overheated Right Now
Clean/ Green A Basket of Government-Subsidized Experiments and Some Shares of GE
Deep Value We Will Invest in Sewing Machine and Typewriter Companies
Premium We Will Pay Up for High-Multiple Stocks/ You Will Pay Up in Fees
Socially Responsible No Such Thing – All Corporations are Evil, Sucker
Diversified We Will Basically Buy the Index and Go Golfing
Enhanced Uses Exotic Derivatives You’ve Never Heard Of
Balanced We Will Underperform Both the Bond AND the Stock Market.  You’re Welcome.
Aggressive Growth Collection of Chinese Online Gaming Stocks and New Jersey Biotech Startups
Lifecycle We Can See 20 Years Into the Future, Only Putnam Knows When and How You Will Die
Moderate Allocation Gutless Fund Manager
Quantitative Manager Will Take Credit for Up Years, Blame Computers for Down Years
Endeavor/ Opportunities We Will Throw Darts
Core No Need to Spread it Out, Send Us Everything You Have

Do simpler disclosures help people make better financial choices?

July 3, 2009

I would have thought so along with other believers in nudge. However, this paper by John Beshears, James Choi, David Laibson and Brigitte C. Madrian says not really. They conduct a laboratory experiment amongst Harvard University Staff and do not find evidence that people make better financial choices:

We use an experiment to estimate the effect of the SEC’s Summary Prospectus, which simplifies mutual fund disclosure. Our subjects chose an equity portfolio and a bond portfolio. Subjects received either statutory prospectuses or Summary Prospectuses. We find no evidence that the Summary Prospectus affects portfolio choices. Our experiment sheds new light on the scope of investor confusion about sales loads. Even with a one-month investment horizon, subjects do not avoid loads. Subjects are either confused about loads, overlook them, or believe their chosen portfolio has an annualized log return that is 24 percentage points higher than the load-minimizing portfolio.

Hmmm..  I am actually not surprised with overall results though am surprised that it does not show any positives. Only thing summary prospectus helps is in making quicker decisions which later analysis reveals is not really great as far as financial choices are concerned. What is worse is the confusion over entry loads continues despite simpler information layout.

I recall SEBI also thinking about summary prospectus (am not sure whether it has been passed).  Though, it is a lab experiment, so we can never really assume it to hold in all cases. But it provides a food for thought as it has interesting and challenging findings.

I often think about this dilemma policymakers have- on one hand try and help people make better fin decisions by using nudges like simple prospectus etc. But on the other hand the financial decision making (even basic simple stuff) appears to be quite difficult for general public and the policy changes don’t really help. And this is not just for general public. I have seen people working in financial industry also struggle in making financial decisions. However, this does not imply policymakers don’t try.

I am hopeful more such studies are carried to get some more understanding of the broad issues on what works and what does not.

The Wall Street Culture that led to crash

May 21, 2009

It is always refreshing to read speeches of John Bogle (available on his blog). He has been questioning the practices in the financial sector for a very long time. His name should also feature in the names of all those people who predicted this crisis. His idea has always been that the people in the financial industry have forgotten that they need to serve the people and instead are just working for themselves. As he is from Vanguard, his severe criticism is always targeted at Mutual Funds.

I was reading his recent speech where he once again raises the same issues:

Relying on Adam Smith’s “invisible hand,” through which our own self-interest is said to advance the interests of our communities, our society had come to rely less on strict regulation to govern conduct in the field of free enterprise—in commerce, business, and finance—and to rely more on open competition and free markets to create prosperity and well-being, and to add value to our society.

But that self-interest got out of hand, and it spread to the very core of our national culture. Simply put, we became what has been called a “bottom line” society, one in which progress and success are largely measured in monetary terms. But our society, I think, is measuring the wrong bottom line: not only money over achievement, but form over substance; prestige over virtue; charisma over character; the ephemeral over the enduring; even mammon over God. Dollars have become the coin of the new realm, and unchecked market forces totally overwhelmed traditional standards of professional conduct, developed over centuries.

He quotes speeches from some people really long ago who had commented on the same issues which are bothering us right now. Why were the warning ignored? Perhaps Simon Johnson comes closest to explaining the events.

He says the society has moved from being an ownership society to agency society where managers have become more powerful than the owners, Speculation has gained wisdom over investments and how mutual funds continue to milk investors by charging high expenses. Here are some points on MF industry:

Example: the average expense ratio of the ten largest funds of 1960 rose from 0.51 percent to 0.96 percent in 2008, an increase of 88 percent. (Wellington Fund was the only fund whose expense ratio declined. Excluding Wellington, the increase was 104 percent.)

Three of the largest advisers, for example, charge an average fee rate of 0.08 percent of assets to their pension clients and 0.61 percent to their funds, resulting in annual fees of just $600,000 for the pension fund and $56 million for the comparable mutual fund

Vanguard’s lowcosts are legendary, by far the lowest in the field. Last year, over all, our operating expense ratio came to 0.20 percent of average assets, compared to 1.30 percent for the average mutual fund. That 1.1 percentage point saving, applied to one trillion of assets, now gives our shareholders an average savings of $11 billion annually. Do low costs matter? Of course they do! As the world of investing is at last beginning to understand, low costs are the single most reliable indicator of superior fund performance.

Shocking numbers really.

I just calculated the average expense ratio of all diversified equity funds in India and it is 2.14%. I am wondering whether the expense ratios have fallen or declined over the years. Looking at the way MF managers are paid in India (see this as well)  it should only be rising. Moreover, we hardly have any discussion in India over MF expenses. There is hardly any reporting of returns after netting expenses. There is hardly any advertisement for passive funds/index funds. The tracking error of index funds I am told is quite high which also is not understood. It is much better to be distributor of the funds (see this as well) or be an institutional investor.

We need someone like Bogle to help us know more  about India’s MF industry.

Mutual Fund or Distributor’s fund?

December 23, 2008

Economic Times has a story on Indian Mutual Funds. The article lists 10 Fund houses whose AUMs have declined severely in November 2008 compared to October 2008 . In order to boost sales:

In their bid to bolster their sagging assets under management (AUMs), mutual fund houses are pampering distribution agents with unique incentives to boost sales. Fund houses are handing out upfront commission and other monetary remuneration to increase fund sales. Instead of annual commission, which was the case until some time ago, fund houses are now offering an upfront commission of 1% for selling gilt and income funds.

Among a host of measures adopted, fund marketers are promising higher commission on schemes sold. In addition to the 2.25% as entry load and 0.5% trail commission, distributors are being offered 0.5% extra commission for everytax saver fund sold.

I am not sure how to react to this story.  Mutual Funds are for retail/small investors but has been in news for all the wrong reasons. First, they seem to be passing on a chunk of returns to distributors. Second, seem to prefer institutional investors instead of retail investors. Third, which has become a latest trend is the compensation packages at these funds turning new highs.

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The US incentive practice catching up in India

November 5, 2008

Religare-Aegon has acquired Lotus India AMC is a known news.  Lotus has faced huge redemption pressures and is making huge losses.

In yesterday’s Mint piece, it indicated such a deal may be on. What caught my eye (and disturbed me) is this:

Another of the four people familiar with the situation said that the top management at Lotus India is unlikely to be retained by Religare Aegon, but that some of them had negotiated good exit packages for themselves.

Good exit packages for employees and below par returns for investors! I had pointedthat in these times small time MF investors loose out (for whom Mfs are designed) and big ticket investors make assured returns. I had pointed earlier that fund managers in India are getting paid the same amounts as in London etc.

The Indian regulators should take note of these developments.

Assured returns in Mutual Funds!!

November 5, 2008

ET pointed to this development in India’s Mutual Fund Industry which came as a rude shock.

With redemption pressures mounting amid a liquidity squeeze, some fund houses have given “guaranteed” returns to big-ticket investors who were willing to bail them out by parking money in MF schemes for a few weeks. Under the arrangement, even if the net asset value (NAV) of the scheme dipped, these investors would be allowed to exit at a higher, pre-agreed NAV — something that other investors in the scheme would be clueless about.

This is how it works: say, the NAV of a scheme is Rs 10.10 when the corporate invests in it; the deal is that the money will lie with the fund for a fortnight, after which the corporate will exit at an NAV of 10.25. Even if the NAV slips to 10.05 after a fortnight, the investor still gets out at 10.25. The fund finds a way to pay this extra 20 paise (per unit) to the investor.

“Either the asset management company pays the extra return, or it can be shown as marketing expenses… However, some funds have charged this as expense in an existing scheme, where expenses can be amortised over the life of the scheme. It’s virtually impossible for investors and even auditors to get wind of this,” said an industry source familiar with such transactions.

Assured returns?? How can Mutual Funds give assured returns to big ticket investors and penalise small investors (r’ber the difference is accounted an expense deducted from the NAV of other investors over a period of time). Is this a mutual fund concept at all?

Reminds of John Bogle who often says, there is nothing mutual about mutual fund industry. Agreed MF industry is under severe stress but you can’t penalise small investors. Instead of cutting expenses, what investors might get is higher expenses and moreover they may not be aware of it all. As it is the investments in Mfs have halved and this might be lower going ahead as well.

The cost of Active Investing

April 17, 2008

I have been looking for this paper for quite sometime. It is from Kenneth French (the one who collaborated with Eugene Fama on various landmark papers). The abstract says it all:

I compare the fees, expenses, and trading costs society pays to invest in the U.S. stock market with an estimate of what would be paid if everyone invested passively. Averaging over 1980 to 2006, I find investors spend 0.67% of the aggregate value of the market each year searching for superior returns. Society’s capitalized cost of price discovery is at least 10% of the current market cap. Under reasonable assumptions, the typical investor would increase his average annual return by 67 basis points over the 1980 to 2006 period if he switched to a passive market portfolio.

I am yet to read the paper. Will add comments if I manage to read it.  Here is a profile of the paper.

The use of Quant Mutual Funds in India

March 19, 2008

The quant mutual funds are making an entry in India. After Lotus India AMC has launched a Quant Mutual Fund, Reliance Mutual Fund has converted its index fund to a quant fund. ET says:

Reliance Quant Plus Fund  will invest at least 90 per cent of the assets in an actively managed portfolio of 11 to 15 stocks  from S&P CNX Nifty index on the basis of a mathematical model. The model will shortlist stocks on the basis of stock price movement and financial/valuation aspects, the fund house said. 

I don’t mind these quant funds but converting an index fund into a quant fund surprised me. I still don’t know why index funds are not treated at par in India. This also brings me back to a point I have made earlier- Are our markets getting efficient? If they are we should perhaps be seeing active funds being converted to a passive fund, not the other way round.

Moreover, the conversion is not to an active fund but a quant fund. The recent Phelps article and Mint edit points the dangers of these quant models and financial engineering.

Above all these funds are being offered to the retail investors!! Do they expect a retail investor to understand these funds? The Lotus Fund has about 230 cr of assets under management. I don’t know how much is retail but it is scary. Lotus also has a tax saver fund based on quant models.

These funds would say we disclose the information and the investor can decide whether to invest or not. I don’t really agree as financial literacy is low worldwide and people don’t understand even simple concepts of finance (even high literate ones). This paper points how investors’ investment in equity markets increases with sensex where it should be the other way round. So to expect them to understand a mathematical model is asking for too much.

It will be better if we concentrate on basics and simpler mutual fund schemes. Alternatively, these funds should only be for institutions and not retail.

SEBI regulates advertisement in Mutual Funds- will it work?

February 28, 2008

India’s capital market regulator, SEBI has been in an overdrive mode for quite sometime. It has been passing regulations at a great speed.

This time it passes a circular on the advertising of Mutual Funds. It says:

The rapid fire manner in which the standard warning “Mutual Fund investments are subject to market risks, read the offer document carefully before investing” is recited in the audio visual and audio media renders it unintelligible to the viewer / listener. 

In order to improve the manner in which the said message is conveyed to the investors it has been decided in consultation with AMFI that with effect from April 1, 2008: 

  1. the time for display and voice over of the standard warning be enhanced to five seconds in audio visual advertisements. 
  2. in case of audio advertisements the standard warning shall be read in an easily understandable manner over a period of five seconds

In its earlier circular(in July 2003), SEBI had said:

In advertisements through audio-visual media like television, a statement “Mutual Fund investments are subject to market risks, read the offer document carefully before investing” shall be displayed on the screen for at least 2 seconds, in a clearly legible font-size covering at least 80% of the total screen space and accompanied by a voice-over reiteration. The remaining 20% space can be used for the name of the mutual fund or logo or name of scheme, etc.

So, SEBI has increased the time of the risk warning statement from 2 seconds to 5 seconds.

The rationale behind increasing the timing is that before people can understand the statement, it has already disappeared. So by displaying it for five seconds, people can understand that investment in MF is risky.

And the rationale behind the warning is that people do might not understand that risks are involved in a MF. Hence, the need for a warning.

I don’t really think that these warnings may help despite the best intentions to say so. The regulators believe that people are rational beings and can take care of their interests as long as information is widely and easily available. So, by issuing these warnings, they will evaluate the risks and take decisions accordingly.

However, numerous research in behavioral economics shows that it is actually opposite. Infact, people are predictably irrational and continue to make the same mistakes.

For instance, research tells me people start investing in equities when markets rises. Their investment is at its peak when the equity markets are also at their peak. The finance theory suggests people should be buying when equity markets are below fundamental values.

One can understand people making mistakes in 1991-92 when Indian economy was just opening up. but to see the same trend till 2006-07, suggests that people do not learn their lessons and invest in equity markets rises along with the indices and enter markets when risks are higher.  

Hence, to assume that people will act rationally by increasing the advertisement time might not work. Moreover, most of the advertisement would show a happy family, prosperous individuals etc the risk warning is more likely to be ignored.

Are India’s financial markets getting efficient?

February 21, 2008

I always keep thinking about the nature of efficiency in Indian equity Markets. Where are we placed? Are markets getting efficient or inefficient?

The usual wisdom is that equity markets are getting efficient by the day. This is because the infrastructure (regulations, technologies etc) needed to these markets more effcient has become much better. The trading is on electronic exchanges where arbitrage can be snapped in a fraction of a second. The people can see the various trades on their computer screens from anywhere across India.

However, we have other side of the story which tells me that markets might actually not be getting efficient at all. One good indicator is to see the performance of active finds vs passive funds (index/ETFs).  If markets are getting efficient one shouldn’t see active funds beating passive funds by huge margin and atleast the margin should be shrinking over the years.

As this story shows, passive funds have been increasing in India. But this analysis (and even this debate) says, active funds continue to beat the passive funds. Some might say that most of these analysis don’t point to the risk adjusted, expense adjusted return. Even if we discount all this, I think we should be seeing active funds outperform indexers over the years.

Another point is this story from Mint. which says the cost of fund managers has been increasing at about 300% and Indian fund managers might get the same salaries as those in London, Singapore etc. Now, if the markets are getting efficient we should see the salaries declining as arbitrage opportunities are at best getting limited and is not worth the cost.

So, which side do we lean? Towards efficient or inefficient side? If they are efficient, then active funds shouldn’t outperform. Why do fund managers get such huge salaries? Basically for outperforming markets. Does it mean we have many Buffets in India?

Raghu Rajan in his speech identifies 4 sources of alpha:

  1. One comes from having truly special abilities in identifying undervalued financial assets—Warren Buffet 
  2. Activism- This means using financial resources to create, or obtain control over, real assets and to use that control to change the payout obtained on the financial investment like a Venture fund, etc
  3. Financial entrepreneurship or engineering—investing in exotic financial securities that are not easily available to the ordinary investor, or creating securities or cash flow streams that appeal to particular investors or tastes. Of course, if enough of these securities or streams are created, they cease to have scarcity or diversification value, and are valued like everything else. Thus this source of alpha depends on the manager constantly innovating and staying ahead of the competition.
  4. Finally, alpha can also stem from liquidity provision. For instance, investment managers, having relatively easy access to finance, can hold illiquid or arbitrage positions to maturity: if a closed end fund is trading at a significant premium to the underlying market, they can short the fund, buy the underlying market, and hold the position till the premium eventually dissipates. What is important here is that the investment managers have the liquidity to hold till the arbitrage closes.

Rajan said the first three are difficult and most likely fund managers are retorting to fourth and could lead to a problem in stressful times. His prophecy was quite true  as the subprime crisis showed.(read my post here)

So, there are three questions- If markets are getting efficient, 1) How fund managers are generating alpha in Indian MF industry?
2) If they are not generating alphas, why such huge salaries? 
3) Should these salary levels be regulated?  

Or we can simply say, Indian financial markets are not getting efficient and there are still arbitrages and asymmetries to be profited from.

Should we believe in financial advertisements?

January 2, 2008

I have always taken advice on financial products – mutual funds, stock-selection etc. with a pinch of salt. The thinking goes back to the basics of finance- no matter how good you are, you just cannot predict the price of a share, bond etc. The best information you have is today’s price. Hence, none of the advice really works.

Despite this, we see huge marketing activity in financial sector. We have TV channels, newspapers dedicated to covering financial markets offering advice, suggestions etc. They are sponsored by financial companies who offer stock tips, mutual fund recommendations etc?

This superb paperfrom Mullainathan and Shleifer (one of the best minds in the business) analyses the financial advertisements. They use the behavior finance angle to explain how these finance firms advertise their wares (as Mullainathan is a behavior finance expert and Shleifer makes sense to anything and everything)

In this paper, we compare traditional and behavioral models of persuasion. In the traditional model (Stigler 1961), persuasion is communication of information. “Advertising may be defined as the provision of information on the availability  and quality of a commodity” (Stigler 1987, p. 243). In other words, persuasion involves offering information in order to change beliefs. In the behavioral model, in contrast, persuasion does not aim to change existing beliefs. Rather, characteristics of the product are integrated into the prevailing beliefs of the customer using either factual or spurious messages. There are few outright lies, but many more insinuations aimed at harnessing a pre-existing and possibly false belief.

That is excellent stuff.

They take this idea to test how financial products are advertised and focus on mutual funds (MF). They say a financial product can highlight return, risk or both in their products. Their finding is MF advertise returns when markets are doing well, and risk when markets are doing badly. Ideally, if you believe in your MF, the stance shouldn’t change. But MF know their business. They know people are aware of the market movements and anything contrary to their beliefs will not be accepted. They do a further break-up and find MF advertise growth funds in good times and value in bad times. 

The conclusion is even better:

This conclusion on the nature of persuasion bears on a key question in the analysis market efficiency in general, and price bubbles in particular, namely whether financial institutions play a stabilizing role. Previous research has focused on one form of professional activities, namely arbitrage, and has shown that institutions often play a destabilizing role (DeLong et al. 1990, Brunnermeier and Nagel 2004). But, as Kindelberger (1978) has  recognized long ago, institutions play another important role: they can facilitate or discourage the speculation by individual investors.

Our analysis shows that, at a minimum, financial institutions encourage speculation rather than contrarian behavior through their persuasion strategies. If such persuasion works (something we do not show), its effect is to destabilize prices.

But there is also a broader point. This paper, like Mullainathan and Shleifer (2005), shows that competitive markets in information deliver what consumers want. This, however, need not be the whole truth, or even the data most needed for consumers’ well-being. Whether public policy can improve on these outcomes remains a wide-open question.

The paper is quite a lesson and we see this happening rampantly in Indian financial markets. I pointed out that most mutual fund companies are coming out with infrastructure funds. Why? One reason is that infrastructure is a buzzword but this paper also helps in making us understand that MFs are simply acting on the existing beliefs in the investors.

We are bombarded by the word infrastructure from media and this makes us believe that it is going to be the sector to invest as everybody is talking about it. So, MFs are doing nothing but cashing in.

Now, I don’t mean to say infrastructure is a hype. It is a must if Indian economy has to grow. But this simple ‘name-game’ will not help.  We need viable infrastructure projects and not much emphasis is given to this. The media doesn’t cover this well enough to give you a clearer picture.  Like the way we know which infra stocks went up, we also need to know what were the new projects, the status of the old projects etc. No one seems to care about all this and this is when things get scary.

SEBI waives entry load of mutual funds

January 1, 2008

In what is being called as a new year gift, SEBI waives the entry load for mutual funds in case of direct applications. There has been huge commentary on the issue right since the time SEBI floated the idea. I covered much of it here.

So, what does direct application mean? It means if you download the application from the fund’s website, or submit the application to various distribution centres of the fund, you are not required to pay the entry load. The impact on brokers is going to be small initially, but is expected to be large over a period of time.

SEBI has initiated some quick reforms in the securities market in December 2007. I have covered a few here. It has also made way to allow short-selling in the markets.

Update:

1. Thanks to Vikram who commented saying that direct application means

1. Application without broker code
2. Application with “DIRECT” written in the space provided for distributor code

2. Ajay Shah has written an interesting post on the subject

Infrastucture is the new dot-com

December 5, 2007

Infrastructure has been a buzzword in the Indian equity markets since 2005 but the fervour has been only picking up. The idea was if going for an Initial Public Offer, name your company which should suggests something to do with Infrastructure like power, energy, construction, real estate and now special economic zones and get a higher valuation.  It is altogether a different matter whether you develop any infrastructure. Only name mattered.

If we look at the listof all IPOs listed on NSE till data, we can see:

1. 11 companies have “infrastructure” in name and all IPos after 2007.
2. 10 companies have “Power” in name; again the same story. 
3. 4 have construction – most in 2006.
4. 5 have development (real estate, housing) – most in 2006-07

And we can expand the list. I agree some companies have the fundamentals but all? And that too when the entire infrastructure is in a mess. True. Government has put it on top priority but stll many issues need to be resolved.

Now, I see Mutual Funds cashing in. On a quick glance at SEBI’s what is new section, we can see quite a few new MF cashing on the word.

1. HDFC Infra fund
2. Lotus India Banking and Infra Fund
3. Reliance Infra Fund
4. Tata Growing Economies and Infra Fund (they already have a Tata Infra Fund)

There are already 10 Funds having infra, 3 having power and so on. So funds are trying to cash in by issuing many new funds highlighting the name and raising their Assets under management.

How does a regulator correct this issue? If it does anything, markets would say it is not a regulator’s job to say which names are to be used or not, and if it doesn’t the investors might loose their hard earned money. However, I think investors should be cautioned against emerging buzzwords and then finally Caveat Emptor prevails.

Update 1: Palak Shah of BS adds more info to the infra name.

Update 2: Now IT companies are giving up the IT tag and getting into that infrastructure related name. Palak Shah adds.

SEBI proposes to cut Mutual Fund costs

August 22, 2007

I have lately been quite impressed with SEBI (India’s securities market regulator) lately. The initiatives may not necessarily be in the right direction (for instance on corp bonds) but is certainly helping improve transparency in Indian securities markets.

They have started sharing/publishing data on segments of markets (which were otherwise unknown for instance on corporate bonds, venture capital), are sharing a lot of committee reports. It is also setting up an institute for development of knowledge base in Indian securities markets.

Now, the latest initiative is to attempt to cut down costs paid by investors investing in Mutual Funds (MF). The proposal states:

Keeping in view the interest of the investors SEBI is now considering giving a waiver in entry load for direct applications received by the AMCs i.e. applications received through internet, submitted to AMC or collection centre/ Investor Service Centre that are not routed through any distributor/agent/broker.

What is entry load? Suppose you decide to invest in MF. Say the price (in Mutual fund jargon it is called Net Asset Value or NAV) of one mutual fund unit is Rs 10. And the entry load is 1% then you would have to pay Rs 10.10 for one unit of Mutual Fund. See this to understand how much each MF equity scheme charges as front load. Most charge 2.25% so you end up paying Rs 10.225/- per unit.

This 10 paisa (multiplied by no of units you have purchased) is then kept in a seperate account and is used for meeting selling and distribution expenses. Or in a nut-shell this money goes to your broker. 

Now as we know, brokers are making more money than the mutual funds themselves. So it means most MFs are using brokers as the way to sell their schemes.

Now, as you would realise, as an investor you end up paying more, get lesser units and are on the loosing side. But then what should even MFs do? Most prefer to ride on the existing distribution system and sell via brokers.

Ajit Dayal of Quantum MF tried to sell MFs and cutting down on brokerage but could not win against brokers. No broker was interested in pushing his product. Now he could have given in and agreed to broker’s conditions. But he took them on and is selling the Mutual Funds via internet and word of mouth. But as distributors are very powerful (have you ever been recommended Quantum AMC) the equity fund run by AMC continues to struggle.

This initiative from SEBI is a welcome one. It would not only push down the costs of the Indian MF industry (and this would mean more returns in the hand of investor) but it would also provide more encouragement and support to likes of Ajit Dayal.

SEBI has invited suggestions/comments  on its proposal. I hope it receives support. It would have been good if SEBI actually published a report as well focusing on distribution costs. It would just help build better and stronger comments on its proposal.

Update 1: Reports from ET, BS.

Update 2: ET supports the move in its edit.

Update 3: Ajay Shah points to couple of articles and his views on the SEBI move. His view is that it is a great move but is a pretty small one and would not challenge the distributor driven model. In particular, read this article from Ajit Dayal in IE. He pours his heart out over the state of MF industry.

Dhirendra Kumar of Value Research (a MF rating agency) supports the move as well. His view is distributors are already in a state of panic. Great stuff.

BS (28 Aug., 2007) reports there is a mixed response towards the SEBI move. BS (29 Aug., 2007) has an edit piece on the same.

Update 4: In BS (30 Aug., 2007), there is a story that post SEBI move, MFs have started to expand their branches. As internet is yet to penetrate, MFs are expanding branches to penetrate investors. 🙂

Update 5: ET (3 Sep, 2007) reports that MF managers are split over the issue. They say with entry load waiver, the advisors/distributors of fin products might push insurance schemes ahead of MF schemes, as former offers more incentives to them.

Well, insurance is a financial products designed to sageguard oneself or his products/business from any mishap. Whereas MFs are supposed to help people gain some returns from parting with their savings now for some returns on the savings later. So they are apples and oranges really. The objectives are different. In the end, both might help in case of some mishap but MF may/may not give returns and insurance gives some benefit only if there is a mishap.

So, if a distributor recommends insurance ahead of MF, the industry people are instead saying the entire distribution set-up needs a relook.

Update 6: Ajay Shah points to this excellent article from Gautam Chikermane on the MF-distributor nexus.

Update 7:ET (17 Sep., 2007) reports the relationship managers in Banks (they distribute the mutual funds for banks) are feeling the heat.

Update 8: Ajit Dayal (Quantum AMC) and Nirmal Jain (Indiainfoline CMD) debate whether entry loads should be there.

Update 9: ( ET 24 Sep 07) Want a ticket for Twenty20 Indo-Pak final? You should have been a MF distributor.

Assorted Links

August 22, 2007

1. Fed’s recent move of hiking the discount rate has invited a lot of debate. Based on various ideas, WSJ Blog points out that they can be divided into 4 groups. I belong to “The Realist” group. Which one are you into?

2. Rodrik points out to a new paper by Acemoglu et al. To know more about Acemoglu read his profile here. This new paper would amuse Avinash Dixit all the more or perhaps irritate him.

3. Ashima Goyal in ET says we are understimating investment and growth rates in India. The article provides a lot of food for thought. But it could have  been simpler.

4. In these volatile times what are India’s Mutual Fund mangers upto? ET says most are using their time to read books. I think they should also spend some time in making the MF industry a better place. There are many issues which need to be discussed: number of me-too schemes within the same fund house, high costs, low retail money etc.

Indian Mutual Fund Industry’s outsider

August 10, 2007

I came across this story in ET of Ajit Dayal, Director of Quantum Mutual Fund, India. I knew that Quantum does not give the distributors any money and markets its MFs by word of mouth and distributes mostly by internet. What I didn’t know was the reason.

Most MFs pay huge monies to distributors for increasing former’s assets under management. So much so, that last year distributors made more money than AMCs (Asset Management Companies) themseleves.

Here is Ajit Dayal’s story:

The story behind Quantum Mutual goes back to late 2005, when after getting permission from Sebi to start his own AMC, Ajit Dayal met several distributors to create awareness about his funds. But he was shocked to see them put forth ‘a pricing sheet’. For 6% commission, you’ll get Rs 6,000 crore, for 5%, Rs 500 crore and so on, distributors told him. “Without bothering to check whether a product is suitable for investors, they came up with a sliding fee structure,” reminisces Mr Dayal, who is one of the first stock analysts and investment managers of the post 1991 era. “But who is going to pay for all this?” he asked them.

The last straw came when Mr Dayal went to a senior broker and asked him to recommend his funds to investors, but refused to pay him the hefty commission that he demanded. “We make elephants in the industry dance to our tune, you are just an ant,” thundered the broker. The decision was made. 

He has taken this agenda of selling Mutual Funds to people with as low cost as possible and has some useful articles on its website on how distribution costs can lower returns . 

How about the performance?

The AMC just has 2 funds one equity and one liquid.

Equity fund is called Quantum Long Term Equity which was launched in Feb-06. As per Valueresearch, the AUM is just about Rs 37 crores (Rs 370 million) compared to giants like HDFC Equity which is at about Rs 4600 cr. It ranks 139th in AUM size out of a list of 167 equity schemes.

In terms of returns, it has given around 30% in last one year compared to JM basic which has given 70%+. It ranks 131 in 161 schemes. The numbers for other tests like Sharpe Ratio, Alpha are not calculated as it is just about an year old. 
 
So performance of the quantum equity fund has to be spruced up as it lacks behind its peers by a huge %. It may have lower costs but can only be recommended if it produces returns higher net of costs. Other funds may have higher costs but produce higher returns as well.

But still, a great initiative and as it is only one year old, only time will tell how well Quantum fares in its objective.

I have a suggestion which could lower further costs. The equity fund still has high expense ratio = 2.5% which is just like its peers. It has its office in Nariman Point, the area which has the highest commercial rent and is one of the costliest in the world. It could do with an office at a less costly place in Mumbai.

Assorted Links

June 21, 2007

1.  TK Arun in ET says we should not worry about Rupee getting stronger. His summary is:

The short point is that a stronger rupee right now would help the economy consume and invest more and to enhance Indian ownership of assets in India and abroad.

I don’t really agree to his viewpoint. Firstly, we do not really know what is the right level of rupee. As India has current a/c deficit, the rupee should depreciate but because of capital flows the new effect is appreciation of the rupee. This means worsening of the deficit as imports become cheaper. And then we have RBI intervention which is done in an opaque manner and it is only of Friday we come to know how much RBI intrevened in the markets. More clarity is needed.

2. Super economics blog from WSJ. Thanks to Marginal Revolution for the pointer.

3. Mutual Funds business is a mess. SEBI Chairman says the growth is mostly in liquid funds and that too from corporates. It is hightime something is done about the Mutual Fund business- lot of schemes by one AMC with similar objectives, mostly used by corporates, high expenses, no idea about number of individual investors etc are some very important issues which have to be answered.

4. SEBI takes out a consultative paper for listing and trading securitised paper. Here is ET’s view . Here is the paper. I am a bit confused after reading ET’s view. SEBI should do something about its website.


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