Investors' Hangout: Should mutual funds investing in IPOs worry you?

In recent times, there has been a lot of criticism around mutual funds investing investors' money in new-age companies like Paytm, Zomato, or Mamaearth. What do you think is the rationale behind mutual funds investing in IPOs in the first place?
Of course, every mutual fund invests to make money. Now, they go wrong. And most of the time they go right, and if they go right, then it translates into meaningful returns. Once in a while, they go wrong. And if they go wrong with a company which is older, people don't notice it, nobody comes and says that okay, you invested in this company, and ever since you invested it went down by 10 per cent and why did you do that? In the case of IPOs, it becomes noticeable, you bought it at this price, you bought it at IPO and ever since then it has gone down by 30 per cent. I think mutual funds do invest with a mindset of making money in the short run or in the long run.

There are two aspects to this. One is that it is interesting to talk about that oh look at this, here's a great fund manager who is expected to be an expert and why he's doing such a thing that where he goes wrong and more likely to go wrong. And then the second aspect is that what people don't take into account is what is the context? What is the portfolio view he has taken? Maybe a fund manager has just invested 1,00,000 shares of a company and with a mindset that okay here is if I get allotment and if it trades at 10 per cent premium to its IPO price, he will sell. He may not be a long term investor.

The mutual fund managers are always a combination of two-three things. They are a long term investor with many stocks, they are a short term investor with some stocks and they are a tactical investor with many stocks. I don't know what the stocks are. And if there is a possibility that there could be a bad company, it may not make money, the company may not make money, but there is a demand supply dynamics in the IPO where it becomes a very favourable lottery, if you get an allotment you will make money. If the fund manager is of that view. So, there could be many things which could be driving that decision. And one should not forget that despite all this, it is not very alarming, because in the context of a mutual fund when it is Rs 1000 Crore fund and if the fund has invested Rs 10 crore, how meaningful it is, and normally these new generation IPOs are an even smaller component of the overall fund.

But do you think that mutual funds are taking unnecessary risk by investing investors' money in these new-age IPOs and how different is that from an investor investing directly in such companies?
One is that I don't think fund managers are taking a disproportionate risk because as I was saying, the sense of proportion we should not forget. Whether it is point 0.005 per cent of the portfolio, it might look like 5,000 shares or 50,000 shares or 5 lakh shares, but in the overall scheme of things, in the overall context, how meaningful it is. That is one. The other is that I would be worried about a fund which is taking such calls and going wrong often and that will show in it for poor performance and that will not be part of our recommendation. So, the bottom line is that the funds should do well consistently over a period of time. And if it goes wrong overall, it will not be doing well consistently over a period of time. So I don't think it is that alarming, but at the same time I will be very wary of a fund which is taking such calls very often and going wrong.

How different is this from an investor investing directly in IPOs?
It is no different except that when an investor does it, of his Rs 50 lakh he just might be doing for Rs 2 lakh or Rs 5 lakh, which could be more. In case of a mutual fund. It could be very insignificant. It might be very noticeable, it might be talked about, it might be the talk of social media, but it means nothing, because in the overall scheme of things, it might be insignificant.

In case of an individual investor, there are two problems. One is that if you're going to invest Rs 2 lakh in an IPO, then you have to keep Rs 2 lakh handy, which means that you will not be doing that SIP. And there could be occasions when there could be five IPOs scheduled in this month. So, will you keep that much liquidity? I would say that if I have to choose between increasing the amount of my SIP as compared to investing in an IPO, I will give the IPO a pass.

In this scheme of things, how worried should an investor be with mutual funds?
I would say that, not at all. It is insignificant. Just take note of the fact that the funds are doing it. And if they stopped doing well, the fund themselves stop doing well, you can actually blame it on their attitude towards what kind of risk they're willing to assume? And where do they tilt in terms of what is their betting average, do they go wrong? Do they go right? After all, all investing is about taking a call on a company and its likelihood of doing well. And if you take a call and you go wrong often and it does not work out, it doesn't play out favourably for you, it is not a desirable fund manager to be entrusted with your money. So, that is something which you should keep in mind.

So, looking at fund performance is one aspect. And I think the most crucial aspect is that is it in line with what you expected. I will be careful about a certain kinds of funds, like for example, if there is a fund which has which has a given mandate - a thematic fund or a sector fund or a kind of small cap fund which is investing in a large cap company or some such thing - those kinds of style impurity, if somebody is getting distracted and investing in a company which does not fit into its portfolio, then I'll be more alarmed by those things, those indiscretions than a fund investing in an IPO of a company which does not make profit.

Individual investors do a variety of things. Just last Diwali, gold coins were available in BlinkIt and it was getting delivered home. And then you keep investing in IPOs and you remember the ones where you made profit and you forget about the ones where you made losses. I think investors should be disciplined about their investments and don't get distracted by so much because there could be a great fund which invested in one of these IPOs and because it is getting bad press, you will be distracted, you will start holding a negative view on that. That is avoidable.

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Also read: Learning from IPOs

This article was originally published on November 20, 2023.