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When Fund Managers Play Musical Chairs

Indian mutual funds have suffered a furious rate of fund manager churn. This is bad for the industry, no matter how much fund houses may gloss over it

A recent exercise at Value Research to select the most investment-worthy funds across the equity, debt and hybrid categories revealed a discomfiting fact. Most Indian mutual funds schemes seem to endure a furious rate of fund manager shuffle. Of the 150 equity funds analysed, over a fourth had seen a portfolio manager change in the last one year. Over 80 of these funds had seen manager churn within the last three 3 years.

And only two funds out of the 150 (HDFC Equity and Principal Global Opportunities) retained the same portfolio manager for 10 years. Debt funds were no better with nearly 28 per cent of the funds having seen a manager change in the last one year.

Now, as these shortlisted funds had managed good returns despite the churn in managers, does the shuffle really matter, you may ask? Actually, it does. There are three key problems with frequent changes in the portfolio managers of mutual fund schemes.

Drifting style
Fund manager changes can bring about a change in the fund's investment style, market cap or risk preferences. Now, fund houses will hotly deny that individuals have anything to do with style or risk and explain that they have a wonderful "process" to deal with portfolio construction.

But this is gobbledygook. Individuals differ in their approach to investing and risk-taking. If you look at the long-running funds in the Indian equity space (the ones which don't madly change their portfolio managers), you can see a clear difference in their manager's styles (value or growth), risk preferences (some prefer concentrated holdings, some like it fragmented) and even market cap bias (some managers love microcaps, others won't touch them with a barge-pole).

Therefore, as long as funds are run by real people, these human characteristics will reflect on the fund's portfolios and performance. Therefore, it is quite possible that, due to a manager change, a value fund suddenly morphs into a value-and-growth blend or a midcap biased fund starts to add large-caps.

Track record
Such a drift in the fund's style or portfolio holdings may make its past returns less indicative of its future. If a fund which has all along loved to buy low PE stocks suddenly starts to seek out high-growth ones, you can be sure that this will impact its returns, as well as ability to manage downside risk.

Ditto for a bond fund which hitherto stuck to AAA bonds, but suddenly begins to allocate to lower rated ones. The accruals may be higher, but will come with higher credit risk. Given that mutual fund mandates in India tend to be quite vaguely defined ("will invest in equities for capital appreciation"), such a style drift can quite easily happen.

Now, tracking any scheme's fund manager changes is an arduous task (unless you like to go through dozens of addenda) for the lay investor. Therefore when fund undergoes a style change due to manager shuffle, an investor may be quite puzzled to find a fund he thought to be Dr Jekyll, morphing silently into a Mr Hyde.

Attrition
A third problem that is worth pondering on is whether portfolio managers in the mutual fund industry, who advise us all to be 'long term' and to 'stay the course' through the ups and downs of market cycles, are themselves following this advice.

Many of the fund manager changes in the analysed funds took place because of role changes within the same fund house, But some were also triggered by fund managers jumping ship, simply quitting one AMC and moving on to another AMC. Now, it is well known that the financial services industry has attrition rates next only software.

But it would surely be a pity if Indian fund managers jumped ship so often that none of them had the opportunity to build a long-term track record.

Whatever mutual fund houses may say about fund performance being a team effort and there not being any 'star managers', there is no doubt that some individuals have a special talent for consistently picking winners, whether in stocks or bonds. Today, investors in India look up to long tenured managers such as Prashant Jain (HDFC Mutual fund) or a KN Sivasubramanian (formerly Franklin Templeton) for their unique stock picking skills. But such role models are less than a handful in number.

It would be a pity, if over a 20 or 30 year time frame, the Indian mutual fund industry yielded no money manager with the track record of An Anthony Bolton or a Bill Gross. So closely was Bill Gross identified with Pimco's Total Returns Fund that his exit alone has triggered billions in outflows from the fund.

This may seem like a scary situation to mutual fund bosses, but it is also a testimony to the power of a great money manager to create wealth for lakhs of inexperienced retail investors. Ultimately, isn't this what mutual fund investing all about?