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Investors don't hear the fund manager

Bigger the category, better is the performance because of the underlying holdings and sustainability over market cycles

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This old article may have references to outdated tax rules and laws. For up-to-date information on taxation of mutual funds, refer to

Investors don

Every market cycle brings about some lessons for fund managers.

But this time it has been different.

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Since 2008, markets have not gone up in secular fashion. International events, too, leave an imprint on us and add to the volatility. The purpose of this panel discussion is to find out how fund managers cope with such volatility. Anoop Bhaskar, head (equities), IDFC Asset Management Co. Ltd; Prashant Jain, executive director and chief investment officer (CIO), HDFC Asset Management Co. Ltd; Santosh Das Kamath, managing director and CIO, fixed income-India, Franklin Templeton Asset Management India Pvt. Ltd; Mahesh Patil, co-chief investment officer, Birla Sun Life Asset Management Co. Ltd; and Shyam Sekhar, chief ideator and founder, iThought, are the panellists. The discussion was titled 'Challenges for the status quo: how fund managers are coping with increased volatility', and moderated by Kayezad E. Adajania, deputy editor, Mint Money. Edited excerpts: Adajania: Prashant, you have gone with your convictions. You have invested in public sector banks. The past few years have been tough for you.

In hindsight, do you still stand by your convictions? Jain: Some of my best calls have caused pain in the first few years. If the initial rationale is sound but the environment does not lead to the desired outcome in a short time frame, one needs to be patient. Over time, results should come.

Oil companies-HPCL, BPCL-are classic examples. They have now delivered returns that have made the entire wait worth it.

Coming to banks, I prefer the word 'corporate banks'. Banks-both public and private-that have given money to companies are in pain. It's not a question of public versus private banks, it's simply a question of where your loans reside, companies or individuals. Thus, corporate banks, both in public and private sectors, have seen high NPAs (nonperforming assets), high provisioning costs and a fall in valuations.

Corporate banking is a cyclical business, and currently we are passing through a challenging period. Valuations are cheap in challenging times and for the value to unlock, one has to wait for the times to change and for the performance to improve. In my opinion, this will happen as was seen in a similar cycle in late-1990s and early- 2000s.

But, yes, I accept your criticism that the pain has (lasted) for longer than what one would have liked.

We tend to measure performance in terms of one or two years, but equity market cycles are longer. The good thing about equities is that while the wait may be long, they tend to reward in a relatively short period of time for the entire holding period, when the environment becomes favourable and when the underlying companies' performance improves.

Adajania: Santosh, do you think such a level of conviction is bordering rigidity? Is it worth taking all that risk? You, for instance, have been bullish about taking risk on the credit side. You sold JSPL (Jindal Steel & Power Ltd), while many other fund houses that had the same paper, did not.

Kamath: On the fixed income side we are slightly better off than equity.

People think it's a negative, but it's actually a positive.

In fixed income, if you want a tax benefit, you have to stay for 36 months.

That itself makes people stay. So, any investor who comes in my fund will have a 36-month view, especially for corporate bond, income or dynamic funds.

Why do we have to give equity (funds) the tax benefit? They keep promoting equity funds for three, five, 10 years.... They may not like this, but I think tax benefit should be applicable if the investment is for five years. Why have incentives to stay put for one year? According to data by Amfi (Association of Mutual Funds of India), 50% of equity fund investors withdraw before they complete two years. Give the tax benefit after three or five years, and people will stay that long.

In fixed income at least I have the luxury of three years. Apart from what happened to us in a particular stock, our three-year performance is in the top quartile.

Secondly, a lot depends of the company you work with. If a company understands investments, it will know that the path can never be smooth. My boss in the US tells me that any time he sees a consistent first quartile fund, he worries. If the company understands that things can be volatile, then the fund manager can stay with convictions for long. If not, then the fund manager will have to change stance, or the company.

So, fixed income funds play the conviction role slightly better than equity funds.

Adajania: Shyam, when a fund is impacted due to the strategy its fund manager adopted, at such times do investors have the patience or the ability to understand or appreciate the fund manager's line of thought?

Sekhar: A recent popular post on Twitter was about the most popular fund manager in the US, in Fidelity Magellan, Peter Lynch. It said that a very small number of investors took advantage of Lynch's best phase. The predicament faced by Indian fund managers is the same.

This quartile mindset itself is not going to create good investments from an investor's standpoint because you are trying to judge something over short periods of time.

Typically, a single stock that moved fast and which a fund manager owned at that point, would create short-term outperformance. If you give all the money, as an adviser or an investor, to that fund manager, there is no guarantee that you are going to see that sustain.

We should first focus on the fund manager's conviction.

Sadly, investors don't have patience.

The underperformance is driven by top-down macro investing, which is taking time to play out in returns. So, this is a phase in which investors are worshipping micro-investing and rejecting macro- investing.

When you say it's a pain point for the fund manager, I feel that's not being fair to the fund manager or to his conviction or to the philosophy that macro-investing delivers larger long-term returns and for larger sums of capital. Ultimately, we need to move billions of dollars.

If we take a view that's opposite, it does not serve the industry, or the investor, or the intermediary. But that seems to be the mood of the moment.

Adajania: Could size be a problem?

Bhaskar: Look at the mega-caps of India, which would be the top 50 percentile by market cap. In 2001, there were 15 of them. All 15 survive today; all are mega-caps. In mid-caps and smallcaps, roughly 25% companies either move up or move out. So, for a large fund, the biggest risk is having stocks that will move out of that segment.

In the small-cap segment, which is the darling today, one-third of the stocks actually move down to micro-cap each year. In terms of mortality rate- which people don't look at because they are looking at returns-the best chance of survival is in large- or megacaps.

In India, volatility is in returns, not capital. Risk is when you lose capital completely.

Adajania: Prashant, your HDFC Equity Fund is about Rs16,000 crore. Do you think size contributed to its underperformance?

Jain: All mutual funds in India collectively have less than 5% of the market.

The single largest scheme is 0.15% of the market. So there are no large funds.

In fact all schemes are minuscule relative to the markets. Size is thus not a constraint to the performance of any fund in India.

Both large and small funds have their good and bad years. However when a large Fund has a weak year, it is noticed by a larger number of investors and a typical reaction is to attribute it to size as it stands out.

Smaller funds escape such scrutiny even though there may be similar or larger number of smaller funds that are not doing well in a year.

Adajania: In these volatile conditions, what role do trustees play? Do they have the capacity to question the fund managers?

Patil: In their supervisory responsibility, trustees will normally question underperformance vis a vis the benchmark.

At times, there could be strategies that have not played out in the shorter term.

A fund manager would have a reasonable argument as to why this happened.

But in our industry, we have to give a report to the trustees every financial year. There is questioning from the trustees, but a fund manager must have clear arguments and convictions. Also, one should explain in a broader time frame.

The investment committee plays a more important role in an asset management company (AMC). Here one has to explain the underperformance.

So, if the investment committee is strong and has capable people, it can play a much more important role.

Adajania: We never hear advisers or fund managers tell investors don't invest because valuations are high. Should that happen?

Sekhar: This call has to come from a level higher than the fund manager's. In the past, funds have raised maximum capital at the peak of each cycle. If you poll fund managers about whether they had the highest conviction at that time, I am sure it was not what it would have been at the bottom of a cycle. See the current trend towards small- and micro-caps. It is not the fund manager who says let's put this on display. But he is answerable for the performance. So, the structure has to come up with more serious accountability.

For instance, in 2010, what if you had not offered a technology fund, but a hybrid product? Same in 2008. What if you had not raised Rs30,000-40,000 crore in infrastructure funds, and said I will give you a hybrid product so that if infra doesn't do well, I will raise my exposure elsewhere? In such a case, the damage of the subsequent years would have been far better contained.

The same people who say thematic is risky, have put thematic in the display window. The accountability for this action has to be fixed because we are again going towards thematic marketing.

The fund manager's role in this has to be more overt. The investor doesn't hear the fund manager. Unfortunately, the Indian investor is not as evolved as he should be.

If fund managers want to create capital under their control, it can't be through change in taxes; it has to be through affirmative action.

This old article may have references to outdated tax rules and laws. For up-to-date information on taxation of mutual funds, refer to

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