November 26, 2017

A Nightmare Of Flawed Processes

At the start of this year, I wrote a post: Will You Get Your Money Back, On Time?  In that, I spotlighted the case of an investor who was unable to execute a redemption transaction on the website of a prominent fund house.  His experience was all the more harrowing because, despite his best efforts, he couldn’t reach the customer service team at the fund house.  As an investor, there were two aspects of that episode that I found particularly scary. The first was that the entire incident was the result of poorly designed processes on the part of the fund house.  By my count, there were at least five questionable actions that were triggered through no fault of the investor.  The second was the attitude of the people at the fund house who took no responsibility for what happened.  That made me wonder if they would even bother to examine the flaws of their processes, let alone take any corrective action.

That was not an isolated case: it was just one that warranted a detailed post.  Fact is, I have seen evidence of such flawed processes, across multiple fund houses.  In this post, I would like to present another case, that transpired last week, and which should be of relevance to all investors.  Here, too, the events described could have happened to almost anyone.

This case relates to a Mumbai-based DIY investor who attempted to redeem his investments in a certain ultra short term fund managed by another prominent fund house.  This is a fund house that prides itself on the quality of its processes, and its customer service team.  The investor planned to execute the transaction via the fund house’s website on Monday last week.  But a day before that, on Sunday, when he went on the website to check the exact value of his investments, he was shocked by what he saw.

The summary showed the Account Summaryvalue of his investments as 35.92 lakhs, which was in line with what he estimated.  However, when he opened the account statement, he was stunned to see that the number of units available for Account Statementredemption were zero.  As he wondered why that was the case, he spotted an entry made just a few days earlier, with a cryptic description: “pledging”.  It seemed as if all his units had been pledged, something he was absolutely sure, that he had not requested.

Being a Sunday, he had no way of contacting the fund house.  So frantically, he called up people who might have an answer, but it got him nowhere.  He spent a restless day, and night, and first thing on Monday, called up the fund house.  He didn’t get an immediate explanation but someone assured him that they would get back.  They did, but with a baffling reply.  Apparently, in the course of the last switch that he had made (from an equity fund into this scheme), the fund house had deducted a lesser exit load than what was applicable.  When they realized their mistake, they marked a lien against his units with the intention of recovering that amount.

Right away, that threw up several questions, none of which the customer service person could answer.  Why hadn’t they simply written to the investor, or called him up?  If for any reason, they had to mark a lien, why did they do it on the entire units, given that the amount to be recovered was merely 4,000 or so?  Why couldn’t they explain it better on the account statement, instead of using an ominous word such as “pledging”?  Why were they hassling him in this manner when it was the fund house which was at fault?  What sort of processes did the fund house have in place if it couldn’t calculate the exit loads correctly?   Wasn’t the investor entitled to compensation from the fund house for the mental anguish caused by its actions?

From what I could gather, the investor conveyed his intention to immediately withdraw his entire investments.  The customer service person told him that he could do so, and that the amount would be deducted from the redemption proceeds.  Unfortunately, even after that assurance, things didn’t go smoothly.  As per the fund house’s service standards, the redeemed amount should have been automatically credited to the investor’s bank account, early morning on Tuesday.  That didn’t happen.  Once again, he was forced to call up the fund house and enquire what was going on.  Eventually, a few hours later, the amount was credited to his account. 

Many years ago, someone asked me what was the worst thing that could happen to a mutual fund investor.  To that person’s surprise, my answer then, as it would be today, was that in my opinion, there could be nothing worse for an investor than to not be able to rightfully access his/her money at will.  Just like the investor mentioned here, and the one in my earlier post, I have lived such a nightmare once: I hope that I don’t have to, ever again.  I hope that you don’t have to, either.

Special thanks to Robin Jehangir for bringing this case to my attention.

October 26, 2017

In Praise Of SEBI’s Scheme Rationalization Directive

In the three weeks since SEBI released its circular on categorization and rationalization of mutual fund schemes, there have been at least two dozen opinion pieces written on it, across newspapers, blogs, and online portals.  With a number like that, it is usually pointless to try and add anything new to the conversation.  But after going through what has been written, and speaking with advisors and investors, I feel that SEBI’s circular hasn’t been appreciated as much as it should have.  I think it is one of the most important directives from the regulator in recent times, and deserves a standing ovation.  If nothing else, I’d like to add my voice to that of those who have applauded it.

Here are some of the ways in which I expect it to benefit investors:

You’ll know what you’re buying: A number of fund houses have made it difficult for investors to comprehend the true nature of the schemes that they buy into.  In some cases, the scheme names are misleading while in others, the investment objectives are way too ambiguous.  While the issues with the names may still persist, SEBI’s elaborate description of most categories leaves little wriggle room for fund houses to creatively expand a scheme’s investment objective.  So once this directive comes into effect, if you buy an equity scheme categorized as ‘large cap’, you’ll know exactly what to expect.

You’ll have clearer choices: Currently, choosing between scheme categories can be tricky.  There are at least two issues that investors face.  The first is that there is a lack of uniformity in the way that scheme categories are defined by various entities.  For example, one prominent online portal divides domestic, diversified, non-ELSS equity funds into five categories whereas another splits these into just three categories.  Hopefully, SEBI’s intervention into the classification process will result in all these entities adopting a uniform approach. 

The second problem is that among the prevailing classifications, some categories are so loosely defined that certain schemes could fit into any of two or three different categories.  As a result, there are differences in the way that these schemes are categorized by different entities.  While SEBI’s classification does not completely eliminate overlap, the important difference is that there will now be little ground for an entity to categorize a scheme any differently from the way a fund house does.

As a foot note, I’d like to say that I disagree with those who contend that the SEBI circular keeps far too many categories, particularly among debt funds.  I believe that the number of categories is a less consequential issue than it is being made out to be.  As for debt funds, their structural complexity as well as the widely segmented audience that they cater to, necessitates far many more categories than equity funds.  I think that the categories put forth by SEBI meet that requirement quite well.

Underperformance will be difficult to mask: At present, some fund houses have multiple schemes with similar objectives but with subtly different strategies/ portfolios.  This enables them to hedge their bets on which strategy/ portfolio will do better.  But more than that, this helps in effecting a psychological deception upon prospective investors.  Put differently, if you are a prospective investor who is comparing fund performances in a category in which there are, say, two somewhat similar schemes from the same fund house, you are more likely to notice the better performing scheme (and miss seeing the underperforming scheme).  Thanks to SEBI’s stipulation that a fund house can have only one scheme in most categories, fund houses will now have to necessarily go with their highest-conviction strategies. Hopefully, then, a clearer picture of the true performance of a fund manager should emerge.

Style drift will be curbed: Style drift is far more widespread than most people realize, and is thus a bigger risk than most people realize. Going by the latest SPIVA India scorecard, as many as 53% of the funds that were classified by Morningstar as large-cap 3 years ago (and which continue to exist today), no longer have a large-cap orientation.  In fact, in just the last 1 year, 25% of equity funds that were classified as large-cap, have ceased to have a large-cap orientation.  In case you’re wondering, it isn’t just large-cap funds, or even equity funds.  11% of equity funds that were classified as mid/small-cap a year ago, are no longer classified as such, while 32% of debt funds across Morningstar’s ‘Intermediate Bond’ and ‘Short-Term Bond’ categories no longer fit those categories.  SEBI’s circular is short on the details of how it will monitor style drift.  But the painstaking detail in which it has defined most categories, gives one the confidence that that, in itself, should be useful in curbing style drift, without constraining a fund manager’s flexibility.

You’ll be able to make fair comparisons:  Making fair and accurate performance comparisons between schemes is integral to good investing.  Unfortunately, on account of the issues mentioned earlier (ambiguous investment objectives, style drift etc.), investors are rarely able to do so.  Once SEBI’s classification comes into effect, this should become a thing of the past, and you should be able to make genuine apples-to-apples comparisons of fund performance.  Doubtless, it will take time for the benefits to materialize but from the point of view of investors, this could well be the biggest benefit from SEBI’s directive.

October 04, 2017

Total Return Index Benchmarking

Around six weeks ago, DSP BlackRock MF stated its intention to “compare its funds’ performance” to the total return of their respective benchmark indices.  A few days later, Edelweiss MF made a similar announcement.  While these were noteworthy decisions, I couldn’t quite understand the need for these fund houses to formally proclaim their intentions to the world at large.  To be honest, a part of me felt that these announcements had a holier-than-thou ring about them.  More than that, though, it was the wide media coverage of these announcements that stood out for me.  Sure, it was helpful in spreading awareness about the difference between a Total Return Index (TRI) and a Price Return Index (PRI).  But beyond that, it seemed to me that most of the coverage was hype and lacked clear perspective.  In this post, I’d like to chip in with some scattered thoughts.

TRI benchmarking has little to do with appropriateness
By any reasonable standard, the appropriateness of a scheme’s benchmark index is determined by the similarity of the constituents of the benchmark with the universe of securities that the scheme will invest into.  So, for a scheme that invests in large cap stocks, the Nifty 50 or the BSE Sensex could both be appropriate benchmarks.  It is a fund house’s individual decision as to which index to choose as the formal benchmark.  As for choosing a TRI over a PRI, that has little to do with appropriateness in that sense: it is more like raising the height of a hurdle to jump over. If a fund house chooses a TRI over a PRI, then at best it can be assumed to be signalling its intent to raise the bar for its performance.  Bear in mind, though, that a fund house can raise the bar for its performance in any number of ways, and without making such announcements. 

Where will performance be reported?
Even if a fund house chooses TRI benchmarking, its performance reporting will be restricted to documents that are released by it (e.g. fact sheets, SID, KIM etc.).  So, to investors who prefer to compare scheme performances across multiple fund houses, such reporting will be of little use. 

Investors can choose their own benchmark
No matter what benchmark index a fund house chooses, in analyzing the performance of a scheme, an investor is always free to use whatever benchmark index he or she thinks appropriate.  For example, in all instances of index data used by me on both my blogs, I have used total return numbers only.  It is not as if that is necessarily better than using price return numbers: it is merely an expression of my personal belief.  And I have done so, regardless of what practice the industry or individual fund houses have followed.

The notion of “alpha” varies
There are some who argue that a TRI is a better choice for accurately determining “alpha”.  In my opinion, a lot depends upon how one defines “alpha”.  For those who regard “alpha” as a mathematical formula, it is understandable for them to prefer a TRI over a PRI.  But in my experience, for most people who look for “alpha”, it is just a broad appraisement of the value added by a fund manager.  Sure enough, some of these people assess “alpha” against a TRI but there are many to whom the TRI/ PRI choice may be inconsequential.  There are also those who believe in assessing “alpha” against an appropriate index fund (rather than an index) while there are yet others who, in their own wisdom, assess “alpha” against the returns from a bank deposit.

TRI benchmarking is not new in India
In conversations with investors and advisors, I gathered that quite a few of them were under the impression that these announcements were pioneering/ ground-breaking in the context of the Indian fund industry.  In fact, there was at least one report, in The Economic Times, which credited DSPBR MF as “the first fund house to start with this practice”.  The truth is that Quantum MF has been following TRI benchmarking for years, for both its equity schemes, as well for its Nifty ETF.  Other fund houses following this practice selectively include IDBI MF and Kotak MF (thanks to one scheme taken over from the erstwhile Pinebridge MF).  And then there are some fund houses that have taken a somewhat convoluted approach, if I may call it that.  To take an example, SBI MF compares the returns of its Nifty Index Fund with the Nifty 50 PRI, but measures its tracking error against the Nifty 50 TRI.  As far as I am aware, none of these fund houses trumpeted their decisions and perhaps, for that reason, these haven’t attracted the media coverage that the more recent announcements have.

September 24, 2017

Excessively Expensive Income Funds

For some time now, I have been trying to maintain a watch list of the most expensive plans among income funds.  While expenses matter regardless of fund category, in the case of income funds they have a more consistent and harder impact (than, say, in the case of equity or balanced funds). Much more often than not, higher expenses lead to low returns or higher risk or both. 

While pursuing this objective, one of my most striking observations has been that the plans that I consider to be excessively expensive, account for a large chunk of the AUM in the category.  If I go by last quarter’s AAUM data, then 69% of the money invested in regular plans (i.e. other than direct) of income funds (other than liquid funds and pure debt fixed maturity plans) was allocated to plans that I consider to be excessively expensive.  This could mean one of two things: either my threshold for expensiveness is too low or most investors in regular plans have been sold plans that are way too expensive.  For those who want to explore the truth of the matter, in this post I present a small selection of the income funds on my list.  But before we get into the specifics, there are a few things to bear in mind. 

Firstly, evaluating and explaining a plan’s expensiveness can be a far more complex exercise than most people realize.  In presenting the data in this post, I have opted to keep things simple (some may regard it as an oversimplification).  I have limited the scope of my presentation to non-direct plans, and have primarily focussed on each plan’s expense ratio relative to that of peer group schemes. For the purpose, I have grouped schemes into five categories.  While I have tried to keep things as objective as possible, in any discussion on expensiveness, some degree of subjectivity/ personal bias is unavoidable.

Secondly, against each scheme that I have listed, I have given the current AUM of its non-direct plans.  This is intended to serve two purposes.  For one, it tells you how much money stands invested in these expensive plans.  Additionally, it can help you better understand a plan’s expensiveness.  As a rule of thumb, schemes with larger AUM are expected to have lower expense ratios than schemes with lesser AUM.  Similarly, schemes with larger AUM than most of their peer group should ideally have expense ratios that are below the category average. 

Thirdly, bear in mind that this is a small selection of schemes from my list.  My complete list of excessively expensive plans is too long and complex to be meaningfully presented here.  The plans presented below are not necessarily the most expensive ones: they are some of the most expensive ones.  They have been handpicked to show how widespread the problem of high expenses is.

Lastly, what you see below is not the ideal way that I would like to present this information.  I am compelled to do so because of the constraining ways in which fund houses report expense ratios and AUM data, and because many fund houses frequently change their expense ratios.


Ultra Short Term Schemes
Average Current Expense Ratio: ~0.75%

Expense Ratio
Regular Plan FY 17
Current AUM
Non-Direct
IDBI Ultra Short Term Fund 1.40% 410 cr
ICICI Prudential Savings Fund 1.38% 7,057 cr
SBI Savings Fund 1.36% 3,546 cr
DHFL Pramerica Low Duration Fund * 1.24% 686 cr
HDFC Cash Management Fund - Treasury Advantage Plan 1.13% 10,768 cr

With one exception, this category covers all schemes currently classified by Value Research as ‘Ultra Short Term’.  Data for expense ratios has been sourced from scheme annual reports, monthly factsheets and third party sources.  Data for AUM has been sourced from latest available AAUM disclosures and includes AUM for plans that have been suspended for fresh investments. Schemes whose expense ratios are shaded in yellow have above-average AUM in the category.

* One plan in which fresh sales have been suspended since 2012 but in which there continues to be AUM had an expense ratio of 2.51% in FY 17.


Short Term Schemes
Average Current Expense Ratio: ~0.94%

Expense Ratio
Regular Plan FY 17
Current AUM
Non-Direct
HDFC Regular Saving Fund *1.79%4,517 cr
Franklin India Short Term Income Plan1.57%7,000 cr
Sundaram Select Debt Short Term Asset Plan1.48%307 cr
Aditya Birla Sun Life Short Term Opportunities Fund1.40%4,605 cr
IDFC Super Saver Income Fund - Medium Term Plan1.31%2,057 cr
ICICI Prudential Short Term Fund1.24%6,329 cr

This category covers all schemes currently classified by Value Research as ‘Short Term’.  Data for expense ratios has been sourced from scheme annual reports, monthly factsheets and third party sources.  Data for AUM has been sourced from latest available AAUM disclosures and includes AUM for plans that have been suspended for fresh investments.  Schemes whose expense ratios are shaded in yellow have above-average AUM in the category.

* (1) The expense ratio of the regular plan of HDFC Regular Savings Fund saw one of the steepest jumps in the category from 1.07% in FY 16 to 1.79% in FY 17.  (2) The expense ratio of the direct plan in FY 17 was 1.19% which was higher than the expense ratios of the regular plans of most schemes in the category.


Medium Term/ Long Term/ Dynamic Schemes
Average Current Expense Ratio: ~1.43%

In my opinion, this category as a whole, is somewhat more expensively priced than it should be.  By my reckoning, if it were to have been fairly priced, then at this point in time, the average current expense ratio for this category should have been ~1.07% (disclaimer: based on complex calculations, subjective assumptions, and personal bias).

Expense Ratio
Regular Plan FY 17
Current AUM
Non-Direct
Sundaram Bond Saver 2.61%120 cr
Sundaram Income Plus *2.23%117 cr
Franklin India Income Builder Fund2.08%872 cr
Reliance  Income Fund2.00%499 cr
Aditya Birla Sun Life Corporate Bond Fund1.97%2,947 cr
HDFC Income Fund1.96%1,086 cr
HDFC Corporate Debt Opportunities Fund1.84%10,724 cr
Franklin India Corporate Bond Opportunities Fund1.83%6,237 cr

With one inclusion, this category covers all schemes currently classified by Value Research as ‘Credit Opportunities’, ‘Income’ and ‘Dynamic Bond’.  The inclusion is Sundaram Income Plus which is currently classified by Value Research and Morningstar as ‘Ultra Short Term’.  Since its stated benchmark is CRISIL Composite Bond Fund Index, I feel it appropriate to include it in the present category.  Data for expense ratios has been sourced from scheme annual reports, monthly factsheets and third party sources.  Data for AUM has been sourced from latest available AAUM disclosures and includes AUM for plans that have been suspended for fresh investments. Schemes whose expense ratios are shaded in yellow have above-average AUM in the category. 

* (1) Over the last 3 financial years, the expense ratio of the regular plan of Sundaram Income Plus has seen a remarkable level of fluctuation, changing from 2.17% in FY 15 to 0.38% in FY 16 to 2.23% in FY 17.  (2) The expense ratio of the direct plan of Sundaram Income Plus in FY 17 was 0.22%.  As far as I can make out, the difference between the expense ratios of the regular plan and the direct plan of the scheme was the highest for any pure-debt scheme.


MIP Schemes
Average Current Expense Ratio: ~2.15%

In my opinion, this category as a whole, is way too expensive.  Consider this: in the case of many fund houses, if you were to create an MIP-type allocation on your own by investing in their most expensive equity scheme, and their most expensive debt scheme, that would be cheaper than investing in their MIP schemes.  By my reckoning, if it were to have been fairly priced, then at this point in time, the average current expense ratio for this category should have been ~1.26% (previous disclaimer applies).

Expense Ratio
Regular Plan FY 17
Current AUM
Non-Direct
DSP BlackRock Monthly Income Plan2.60%447 cr
HDFC Monthly Income Plan - Short Term Plan2.60%322 cr
BNP Paribas Monthly Income Plan2.59%327 cr

This category covers open end income schemes that allow for marginal equity allocation, and which are targeted at investors seeking regular income.  Data for expense ratios has been sourced from scheme annual reports, monthly factsheets and third party sources.  Data for AUM has been sourced from latest available AAUM disclosures and includes AUM for plans that have been suspended for fresh investments.


Closed End Income Schemes With Marginal Equity 
Average Current Expense Ratio: ~2.31%

In my opinion, this is, by far, the most expensive category of income funds.  In terms of asset allocation and return potential, it is similar to the category of MIP schemes.  However, the essential running costs of these schemes are less (lesser servicing costs, lower portfolio turnover etc.).  As a result, there is a case to say that the average expense ratio in this category should be less than that of MIP schemes.  There is also a case to say that the expense ratios of many plans in this category reflect fund house-distributor collusion with the intent of milking investors, at its ugliest.  By my reckoning, if this category were to have been fairly priced, then at this point in time, the average current expense ratio should have been no more than 1.26% (previous disclaimer applies).

Average Expense Ratio
Regular Plans FY 17
Current AUM
Non-Direct
HDFC Capital Protection Oriented Fund - Series III2.69%322 cr
DHFL Pramerica Hybrid Fixed Term Fund (Multiple Series)2.65%634 cr
Sundaram Hybrid Fund (Multiple Series)2.65%520 cr
Axis Hybrid Fund (Multiple Series) *2.53%6,474 cr
ICICI Prudential Multiple Yield Fund (Multiple Series)2.51%1,364 cr
Kotak Capital Protection Oriented Scheme (Multiple Series) ^^2.44%426 cr
ICICI Prudential Capital Protection Oriented Fund (Multiple Series)2.34%3,277 cr

Data for expense ratios has been sourced from scheme annual reports and third party sources.  Data for AUM has been sourced from latest available AAUM disclosures.  While compiling the data, only plans that were in existence on the date of compilation i.e. 21 Sep 2017 have been considered.

* 93% of  the current AUM of Axis Hybrid Fund has come via associate distributors such as Axis Bank.

^^ As far as I can make out, Kotak Mahindra MF does not follow SEBI directions/ industry practices in reporting plan-wise expense ratios in its annual reports. The expense ratio number given here includes both direct and regular plans.  The actual expense ratio for regular plans alone can be assumed to be higher than what is mentioned.

August 29, 2017

Hazards Of Hybrid Funds

At the end of last week, the trailing 12 months return of one of the balanced funds managed by ICICI Prudential MF (I-Pru) was 5.5%.  In itself this may not mean much, but look at this along with the following information:

  • Over the same period, the returns of the open end, domestic, diversified equity funds managed by I-Pru ranged from 7.7% to 23.2%, while the returns of its debt funds ranged from 6.8% to 11.3%.
  • Going by month-end disclosures over the past 12 months, the balanced fund had, on an average, 82% of its portfolio in equities.

Thus, a hypothetical investor who had the misfortune of investing 82% of his/ her portfolio into the worst performing equity fund (in terms of returns) and the balance into the worst performing debt fund, would have seen a return of 7.5% over this period.  So how is it that this balanced fund was able to generate a return of only 5.5%? 

Frankly, I can’t think of any generous explanation for this.  Even the fact that this fund had a higher expense ratio than almost all of the other funds managed by I-Pru, can hardly explain the difference in these numbers.

For whatever you may find this to be worth, this particular balanced fund also happens to have a patchy record in protecting downside risk during market falls/ crashes.  By my estimate, in the 2015-16 fall, this fund gave a worse return than 35% of pure equity funds across the industry while in the 2008-09 crash, it gave a worse return than 76% of pure equity funds (including sector funds).

This may be an extreme example, but the instances of hybrid funds giving questionable returns are far more frequent and widespread than one may realize.  As quick and dirty evidence, consider this: when I zipped through the performance numbers of the past 12 months, I counted 25 hybrid funds that gave less returns than every single equity fund and debt fund of their respective fund houses.  When I increased the time frame to cover the returns over the past 36 months, I counted 23 hybrid funds that gave less returns than every single equity fund and debt fund of their respective fund houses.  In my counting, I tried to avoid including funds which have exposure to gold.

For those who may like another, more specific example, let me share with you some information that recently came my way, regarding Axis Hybrid Fund – Series 5.  This is a closed end scheme which can have up to 30% of its portfolio allocated to equities.  It was launched in July 2013 with a tenure of 3.5 years, at the end of which it was rolled over.

At the time of its launch, 3 year AAA bonds  were yielding between 8.5%-9.5% p.a., and over the original tenure of the scheme, the BSE Sensex TRI grew by over 11% p.a. Despite this, the fund managed a return of just 6.2% p.a.  What makes this number even more dubious is the fact that over that same period, the debt funds managed by the fund house gave returns ranging from 8.6% p.a. to 10.4% p.a. while their equity funds gave returns ranging from 12.5% p.a. to 23.6% p.a.  If instead of investing in this hybrid fund, investors had put 80% of their money in their worst performing debt fund and the balance in their worst performing equity fund, they would have got a return of 9.4% p.a.  Once again, I cannot think of any charitable explanation for that fund to have given a return of 6.2% p.a.

But that’s not all.  Along the way to earning those meagre returns, investors were exposed to extreme fluctuations.  In calendar year 2014, the fund gave a return of 21.6% while in 2015 and 2016 its returns were –2.1% and 0.2% respectively.  From what I can make out, the pattern of questionable returns and extreme fluctuations continued in subsequent, similar schemes launched by the fund house.

Generally speaking, neither do I invest in hybrid funds, nor do I recommend them.   There are three things, in particular, that make me uncomfortable.  The first is the fact that most hybrid schemes do not stipulate what sort of equity shares will they invest into (large cap, mid-cap etc.) or what sort of credit quality or average maturity will the debt portion of the portfolio have.  The second is the practice of having separate fund managers for the equity and debt components of these funds.  In my opinion, a few exceptions aside, it results in each fund manager being accountable in a limited way with no one being ultimately accountable for the fund’s performance.  The third is the tendency of many fund houses to have disproportionately high expense ratios for these funds. 

Thus, when I look at performance numbers such as those mentioned above, I find it hard to believe that these are just on account of bad luck.  I prefer to take the view that the absence of a rigid investment framework, combined with limited accountability, has resulted in many hybrid funds being managed recklessly.

August 21, 2017

Watch Out For Clandestine Portfolio Changes

In May this year, Birla MF (now, Aditya Birla MF) announced changes in the names of three of its ‘MIP schemes’: BSL Monthly Income, BSL MIP, and BSL MIP II- Savings 5 Plan.  What is noteworthy about these changes is that these were intended to mask some of the most brazen portfolio changes that I can remember seeing in any scheme in recent times.  Thankfully, two months later, SEBI shot down the name change decisions, forcing the fund house to “reinstate” the original names.  Unfortunately, despite SEBI’s intervention, the portfolio changes continue to remain, largely unnoticed.

In this post, I’d like to spotlight some of those changes and make the case for stricter regulation of scheme portfolio changes.  Equally importantly, what I share here, should serve as a cautionary tale for investors on the need to closely monitor the portfolios of the schemes that they invest into.  Note: This post has been pieced together from publicly available information and conversations with people supposedly in the know.  I reached out to the spokesperson of the fund house for its side of the story but for reasons best known to him, there was no response from his side.

The roots of the name changes of the abovementioned schemes can be traced back to January this year, when someone on the investments team at Birla MF initiated the idea to launch three debt schemes that would have significant exposure to instruments rated lower than AA.  As the idea was bounced around, it was felt that launching new schemes would be time consuming and expensive and, as an alternative, it was proposed that three of the existing MIP schemes be converted into pure debt schemes.  The fund house had four MIP schemes that had been around for several years but only one of those schemes had seen its AUM grow somewhat consistently.  The other three schemes, despite being in existence for an average of 16 years, had a combined AUM of just under 650 crore (as on December 31 2016).  More to the point, in their existing form, these three schemes did not seem to have much of a future.  Thus, it made sense for the fund house to explore the possibility of converting these schemes.  On the flip side, though, there was at least one key obstacle that would have to be overcome.  Converting a MIP scheme into a pure debt scheme would mean, as some would say, a change in the asset class of the scheme, and ran the risk of being rejected by SEBI.  Apparently, a few months earlier, SEBI had turned down a similar proposal by another fund house.

In order to manoeuvre this idea past SEBI, the fund house hit upon a plan to present it, not as a series of scheme conversions, but as a set of scheme name changes.  But to make a credible case, some groundwork needed to be done.  This was to be in the shape of two sets of changes that would be made to the portfolios of these schemes.  The first involved removing the equity exposure of these schemes.   The second involved reworking the portfolios so that there was a greater allocation to debt instruments that were rated lower than AA.  Thus, in March 2017, the work on restructuring the portfolios of these schemes began.  By the end of the month, the portfolios looked very different from those at the end of the previous month (or any earlier month).  The changed portfolios continued through April 2017, and the groundwork for the name changes was in place.

It is in the magnitude of changes made to the scheme portfolios that one can truly understand the lengths to which the fund house was prepared to go to accomplish its questionable objective.  To help you get a sense of that, I have given below a table which shows the extent to which each scheme’s portfolio was invested in equities, and in debt instruments rated lower than AA, before and after the change.  To present a fair picture, for the investments before the change, I have taken the average portfolio holdings for the 12 months from March 2016 to February 2017 while for the investments after the change, I have taken the average portfolio holdings for the months of March 2017 and April 2017.

BSL Monthly
Income
BSL
MIP
BSL MIP II-
Savings 5
Average % of Portfolio in Equities
      March 2016 – February 2017 16% 17% 11%
      March 2017 – April 2017 0% 0% 0%
Average % of Portfolio in Securities Rated A+/ A/A-
      March 2016 – February 2017 9% 9% 9%
      March 2017 – April 2017 41% 43% 43%

Based on month-end portfolio disclosures.  All percentages are calculated on invested portfolios to avoid impact of cash holdings.  Data source: Prudent Corporate Advisory Services Ltd.

By any measure, this would seem to be a radical transformation in the portfolios of these schemes.  If I were an investor in these schemes, seeing such a sudden and drastic shift would make me seriously consider exiting these schemes.  At the very least, I would expect an explanation from the fund house.  Yet, as far as I can make out, no communication was sent to investors intimating them about these changes.  It makes me wonder about the adequacy of the regulations that govern mutual funds that a fund house can get away with making such sweeping changes to the portfolio.  I would argue that making changes of such a magnitude should be subject to the same requirement as is changing the fundamental attributes of a scheme i.e. investors must be given the option to exit without any penalties. 

As for the fund house, I am sure that it would contend that it was acting within the law, and it would be right about that.  I question its sincerity to the spirit of the law, and its morality.  I look at its actions as trampling upon the trust of its investors.

July 28, 2017

Another Baffling Scheme Merger

Mutual fund scheme mergers should be straightforward stuff, or so I thought. 

In a post, last year, I noted my surprise at the demise of Sundaram Growth Fund on account of its merger with Sundaram Select Focus.  For quite some time, Sundaram Growth Fund had been the flagship equity scheme of Sundaram MF and at the time of the merger, it had a 19 year track record with a CAGR of over 15%.  Shortly before that, Sundaram MF had effected another merger: that of two of its MIP schemes.  In another post, last year, I had questioned the merits of this merger on multiple counts, not the least of which was that investors in the less riskier MIP scheme, so to speak, were asked to shift into the more riskier MIP scheme, and without being adequately briefed on the risks in doing so.  To be clear: in both instances, my puzzlement wasn’t with the mergers per se but with the choices made by the fund house related to the mergers.  And now, a few months ago, Sundaram MF, yet again, merged two of its schemes in a manner that has left me perplexed. 

The merger I refer to is that of Sundaram Banking and PSU Debt Fund (S-BPSU) with Sundaram Flexible Fund Short-Term Plan (S-Flex).  In my limited understanding, there was no real reason for these schemes to co-exist in the first place.  Despite claims in the SID that the differentiating aspect of S-BPSU was that it was “the only Scheme in Sundaram Mutual Fund having the mandate to invest predominantly in Debt and Money Market instruments issued by Banks, PSUs and PFIs”, as far as I can make out, for the two years that they co-existed, both S-BPSU and S-Flex had similar portfolios in that respect.  Hence, I’m inclined to believe that the launch of S-BPSU in 2015 was an exercise in duplication, and that the recent merger brought an end to that.  While I will let better minds than mine elaborate on the reasons for their co-existence, I would like to move straight into what I think is the most curious aspect of their merger. 

Right after S-BPSU was merged into S-Flex, S-BPSU should have ceased to exist.  But that’s not quite what happened.  Instead, on the very same date, S-Flex was renamed as – hold your breath - Sundaram Banking and PSU Debt Fund. Lo and behold- S-BPSU was born again!

Right off the bat, this throws up the question: why didn’t they simply merge S-Flex into S-BPSU (rather than vice versa)? 

One answer to this appears to be that the AUM and investors under S-Flex were far more than S-BPSU.  But that still doesn’t explain the need for the change in the name.  Also, consider this: the trailing 1 year return (at the time of announcing the merger) of S-Flex (regular plan) was 7.81% while for S-BPSU (regular plan) it was 9.87%.  This was despite the fact that the expense ratio of S-Flex was less than S-BPSU by 0.33%.  Given that both schemes had supposedly similar portfolios, if that is any indication of their relative performances, it would appear that the better performing scheme was merged into one that hadn’t performed as well.

There is another answer that has been offered by a couple of industry insiders, though without specific evidence.  Hence, you are free to regard this as speculation.  According to them, schemes that are branded as “Banking and PSU Debt” funds, constitute an important sub-category among debt schemes, and have come into being primarily in response to the needs of some big-ticket investors.  Furthermore, they have suggested that many of these investors prefer schemes with a significant track record and AUM.  The erstwhile S-BPSU had neither, while the new S-BPSU has both.  Based on that, it is their view that the merger may have been effected in this manner to acquire these characteristics at one go.

Frankly, I don’t know what to make of all of this: to me it is simply baffling.  Perhaps, Sundaram MF might want to clear the air on this.

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