When friends or relatives ask me about which mutual funds they should buy, the conversation often goes like this.
Uncle: I am very keen on Indian companies with global flavour. Can I buy Magnum Global Fund?
Me: Err... Magnum Global actually doesn't invest in global companies. It is a decent mid-cap fund
Uncle: Oh! Can you suggest a value fund, which only picks stocks which are still cheap in this market?
Me: ICICI Prudential Value Discovery or Templeton India Growth Fund are good choices.
Uncle: But is a growth fund also a value fund? I thought they were very different?
Me: No....ahem, this is a value fund. Don't mind its label.
You get the idea. In India, the adage that you shouldn't judge a book by its cover applies quite well to mutual funds schemes too. You can't judge a scheme by its name. Quite often, you'll find a 'bluechip' equity fund merrily investing in mid-cap stocks, or a 'contra' fund loading up on momentum stocks.
And it's not just equity funds which have mismatched names and mandates. Debt funds do too. Until recently, the top rated ICICI Pru Long Term Debt Fund maintained quite a short duration on its portfolio.
Vague mandates
Of course, misnamed funds are just one part of the problem. Dozens of schemes with generic or vague labels - take 'growth' funds, 'opportunities' funds, 'multicap' funds and 'long term advantage' funds for instance - are even more difficult for investors to decipher, because their mandates can keep changing. They can be large-cap schemes one month and mid-cap ones in another. They may chase high PE stocks one year and dividend yield stocks in another.
Now, this wouldn't be a problem at all for investors if all fund houses only offered a few simple products - one diversified equity fund, one fixed income fund and one balanced fund. Then, investors could simply decide on their asset allocation between equity and debt and buy the funds with the best track record.
But the fund industry has not chosen to keep it this simple. It is constantly adding to the long line-up of schemes by launching more and more funds playing on every possible niche, nuance and sub-theme in the market. At the time of the NFO, fund houses make a song and dance about a scheme's USP- its unique mandate, investment style and stock picking strategy.
Every NFO pitch is usually accompanied by a glossy product note, a multi-page presentation discussing the possible universe and investment philosophy of the scheme, the fund manager's credo and even 'back-testing' data showing how the strategy has delivered momentous results in the last five or ten years. But for an investor looking to understand the USP of an older open end fund, there's a complete drought of information.
If you are able to wade through the 60-70 page scheme information document, you'll find 55 pages of repetitive and largely worthless information that can apply to any scheme. The five pages that do discuss the scheme's strategy will usually describe it in such vague and sweeping terms that you get the impression that the manager can pretty much do anything under the sun.
The monthly factsheets put out by most fund houses leave you no wiser. Most equity schemes have the mandate to "invest in equity and equity related securities to generate long term capital appreciation". And debt products would like to "invest in a mix of debt and money market instruments for an optimum balance between returns, safety and liquidity".
Now, it is only when you have an actual chat with the fund manager of a particular scheme that you actually get to understand its USP. He will tell you if it is a growth style fund or a value one, a multicap fund or a large and mid-cap one, or a debt fund that plays on either duration or credit.
Given that every retail investor looking to choose an older fund for his portfolio cannot be calling up the portfolio manager, he is likely to have quite a hard time deciding whether a scheme's return and risk characteristics are indeed suitable to him. Imagine a 50-year old investor who wants to buy an equity scheme. He may want a scheme with a 70:30 allocation between large and mid-cap stocks and there are many such schemes available in the market. But can he gauge this easily from the latest factsheet or scheme literature? Mostly not.
Apart from creating problems for new investors, vaguely defined mandates also result in some schemes constantly changing their market-cap or risk preferences with market moods. So, a scheme which preferred to invest 70 per cent of its portfolio in large-cap stocks in the sideways market until 2013 may suddenly load up on micro-caps and show splendid returns in the 2014 bull market. A new investor may be taken in by the recent returns, but he should know that the scheme's previous track record is no longer relevant. The person who bought it in 2013 believing it to be a large-cap fund should probably be selling it, following this change in risk profile.
As the fund industry tries to peddle increasingly sophisticated NFOs to investors, it should also work at defining the mandates for its older schemes more precisely. Equity schemes should set out their market-cap, style (value or growth) and risk bias, not only during the NFO, but also on an ongoing basis. Debt schemes need to commit to the issuer (government versus corporate), duration (long versus short) and credit profile of their portfolios. And having laid down such mandates they also need to diligently stick to them.
If the flexibility to drift freely between all kinds of stocks and bonds is what fund managers want, to deliver good performance, it would be best for fund houses to shelve all these NFOs and stick to just one diversified equity, debt and balanced scheme each. That would make life for investors (and advisors) far easier.
This article was originally published on February 12, 2015.
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