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Marketing Breakdown

Marketing-driven theme limitations are the source of much dismay, not just for investors, but also for mutual funds

A few days back, I had a fascinating conversation with the CEO of a major fund company. He lamented that fund companies’ practice of launching ever-specialised thematic and sectoral funds routinely turns around and bites them when the markets turn against that sector or theme.

Here’s what happens, according to my friend. When the markets are behaving in a certain way, fund companies succumb to marketing pressures to design funds according to what will appeal to investors at in that period. This could be a sector like (once upon a time) technology, or it could be broader theme like infrastructure, or it could be a size limit like mid-cap companies, or whatever.

It’s important for the knowledgeable investor to understand that regardless of what the hype says, these distinctions are almost always created because of marketing needs. It is an unfortunate fact that financial products are bought and sold with the same mindset as consumer products and products need to be differentiated from competing products in order to sell them.

However, the problem starts when the market turns against the theme. According to the CEO who spoke to me, investment managers get completely trapped in the fund’s original marketing-driven limitations. There comes a point when they know the fund is going to do badly compared to the general markets, but there’s nothing that can be done. The fund just sits around losing money; the more active investors keep redeeming their funds and the less active ones get set up for a shock when they eventually see what has become of their money. Either way, investors lose money and the fund company loses its customers and its reputation.

Now, it’s up to the fund companies to have the courage to solve the problem at their end, but for the thinking and knowledgeable investor, the solution is straightforward: Never, ever invest in anything, but a completely diversified fund. As the market twists and turns, your fund manager must have the freedom to move to invest in any sector, theme or size of a company.

When you invest in a mutual fund, you are paying a fund manager to make investing decisions for you. It’s his or her job to figure what type of investment is best at the moment. Whether the right area to invest in is infrastructure, FMCG or technology, that’s part of the service that you are supposed to get when you invest in a mutual fund. However, when you get tempted by a fund that’s supposed to limit itself to a particular subset of the market, then you are pre-empting the fund manager and making an investment choice yourself.

Inevitably, the time period over which a narrow theme does well is a subset of the time period over which the entire market does well. This may not appear to be the case over a short timeframe, but in the long run it is always true. The way marketing works, and the way human beings get attracted to some things and not to others, is not going to change. And that means that not only are financial products (not just funds) going to be sold in the same feature-driven way that cars and shampoos and music players are sold, but a good majority of investors are going to choose them in the same way. However, once you understand what’s happening, it doesn’t make sense not to change the way you make your choices.