The Cautionary Tale of Morgan Stanley

Last week saw the announcement that HDFC Mutual Fund was acquiring Morgan Stanley's mutual funds in India. With this, the strange riches-to-rags story of this first foreign fund to launch in India has come to an end. Morgan Stanley's Indian mutual funds were abject failures in every way, and this Wall Street giant's India misadventure was, for years, a sore point with a whole generation of mutual funds investors. The AMC's mismanagement of its original Morgan Stanley Growth Fund (MSGF) that it launched in 1994 became a cautionary tale of how badly a mutual fund investment could go wrong.

MSGF was launched in January 1994 as a fifteen-year closed-end fund. At the time of the launch, it was advertised that it would be a Rs 300 crore fund and allotment would be on a 'first come, first served' basis. In those days of poorly-informed investors, this created a frenzy among investors. Morgan Stanley being the first foreign fund to launch in a freshly opened-up economy made people think that this was some kind of a once in a lifetime opportunity. There were long queues outside places where applications were accepted, with thousands of hopeful investors clutching yellow coloured application forms. In fact, such was the frenzy that there was a black-market for the application forms themselves.

Morgan Stanley collected almost a thousand crore--a huge amount at the time--and as per the actual terms of the issue, it kept the entire amount in the fund--no talk of the Rs 300 crore limit! As it turned out, the stock selection and fund management skills of the this big name multinational were an utter disaster. The fund lost more than 10 per cent immediately after launch and the very first NAV that came out was Rs 8.98 for a Rs 10 unit! And since this was a fifteen-year closed-end fund, investors had no way of getting out even at the NAV. The only way of prematurely exiting was to sell the units on the stock markets and their, the units always traded at a discount. The market price dropped to more than 20 per cent below NAV within days of the listing and never really recovered. Over the first ten years, the average discount was 26 per cent and the peak discounts hit 48 per cent. So if you tried to get out, you got that much less than the already low NAV!

The sheer size of the fund by the standards of the time combined the huge retail participation (practically every mutual fund investor had some money in it) meant that it was a source of huge negative publicity for the very concept of investing in mutual funds. Morgan Stanley itself never recovered from this disaster and remained an inconsequential player, now to be swallowed up by HDFC Mutual Fund. Of course, the AMC made its money. All these years, as investors suffered the AMC itself collected its management fee from the trapped assets and made steady profits. In fact, during the closed-end years it had special permission from SEBI to purchase its own units from the market so as to keep the discount low. However, it never did so in any significant numbers because doing so would have reduced it's profits.

Of course this is hardly the first exit of a foreign mutual fund from India. Many others like Zurich, Alliance, Threadneedle, Jardine Fleming, Sun F&C and others have exited earlier. However, Morgan Stanley stayed the longest and played a uniquely negative role in the industry.

There are many cautionary aspects of the Morgan Stanley tale but the one that is most immediately relevant today is that closed-end funds come with huge risks for investors. This is relevant because closed-end funds are seeing a revival today, ironically as a by-product of regulatory changes that were intended by SEBI to be pro-investor. Not only do investors get locked into poorly-performing closed-end funds, but there is a sharp divergence between the AMC's and the investors' interests.