May 23, 2018

More Questions For Kotak AMC

These are questions that have been triggered by readers of this blog in the wake of my last post.  To make the questions more understandable, I have added context and comments.

Q1: Why should investors in Kotak Opportunities Fund, still stay invested?

As per the latest fact sheet, there are ~138,000 folios under Kotak Opportunities Fund.  I am not an investor, but if I was, I’d need a lot of convincing to believe that the fund house has been acting in my best interests.  Why?  Consider the facts that I presented in my last post:

  • Since 2012 (if not earlier), Kotak Opportunities and Kotak Select Focus have had largely identical portfolios
  • Since 2012, Kotak Opportunities and Kotak Select Focus have had the same fund manager

Despite that (based on daily data from Sep 2009 to Apr 2018),

  • Over 1 year periods, 83% of the time, Kotak Opportunities gave less returns than Kotak Select Focus. 
  • Over 3 year periods, 98% of the time, Kotak Opportunities gave less returns than Kotak Select Focus. 
  • Over 4 and 5 year periods, 100% of the time, Kotak Opportunities gave less returns than Kotak Select Focus. 

As I asked in my post, how is this possible?  Is it purely by chance?  Is the better performance of Kotak Select Focus merely a fluke?  Or is there something else to all of this?

I would like to believe that it is chance.  Unfortunately, for reasons best known to them, the fund house has chosen not to confirm this.  And now, the reader who raised this question, brought some information to my notice which makes me doubtful that this is pure chance.  Consider these facts (based on the last available SID) about how the fund manager has divided his own investments across these schemes:

  • Investment by fund manager in Kotak Select Focus: 3.32 crore
  • Investment by fund manager in Kotak Opportunities: 6.31 lakhs

So what should one read into this?  Does the fund manager lack confidence in Kotak Opportunities?  If so, why not ask the investors in Kotak Opportunities to switch to Kotak Select Focus?

Q2: Leave aside Kotak Select Focus.  Why should investors have any confidence in ANY of their other equity schemes?

Now, why would somebody think that?

I was presented two reasons.

One reason has to do with Kotak Mahindra Pension Fund, which is a JV between Kotak Mahindra AMC and Kotak Mahindra Bank.  As a couple of readers pointed out, it seems that for some time now, the equity schemes managed by Kotak Mahindra Pension Fund have been investing their corpus in equity schemes of other fund houses rather than directly into stocks.  To the best of my knowledge, they are legally allowed to do so.  Nonetheless, it begs the question: why? One reader wondered why couldn’t they replicate the “success” of Kotak Select Focus in that scheme.

The bigger point, though, is that investing into schemes managed by other fund houses doesn’t speak well for an entity that claims the expertise that they do.  It simply doesn’t inspire confidence in their fund management capabilities.

For those who are interested, the table below gives the equity holdings of the Tier I equity scheme managed by Kotak Mahindra Pension Fund.

NPS Trust A/c Kotak Pension Fund Scheme E Tier I

Equity Holdings: 31 March 2018
ABSL Top 100 Fund9.64%
ABSL India GenNext Fund9.10%
ABSL Frontline Equity Fund9.64%
DSP BlackRock Opportunities Fund9.02%
Franklin India Bluechip Fund 9.56%
Franklin India Prima Plus 8.04%
ICICI Prudential Focused Bluechip Fund9.31%
Mirae Asset India Opportunities  Fund8.56%
SBI Bluechip Fund9.45%
SBI Magnum Equity Fund7.22%
SBI Magnum Multiplier Fund9.03%

Scheme names have been reproduced as mentioned in the portfolio disclosure, correcting only for typo errors.  Following the SEBI directed categorization and rationalization, the names of some of these schemes have been changed. 

The second reason is similar to what brought about the first question.  It isn’t just Kotak Opportunities: in all of the open-end diversified, domestic funds managed by the fund house (other than Kotak Select Focus), the respective fund managers have negligible investments, or no investments at all.  The table below gives some details.

Investments by equity fund managers in schemes managed by them
Amounts in Rs. Lakhs

Kotak 506.6111.26
Kotak Classic EquityNilNil
Kotak Midcap0.75Nil
Kotak Emerging Equities1.85Nil

Compiled from SIDs dated 26.06.2016 and 26.06.2017

I want to make something clear.  In isolation, I wouldn’t read much into the extent of investment made by a fund manager.  Yes, I applaud fund managers who make significant investments in schemes managed by them, but I don’t hold it against a fund manager for making a negligible investment, or no investment.  There can be valid reasons for that.  In this case, however, there is at least one thing that is different.

In July 2015, the fund house made a public announcement that “its employees will invest only in its own mutual fund schemes” (emphasis mine).  According to the press release, this was based on a belief that like restaurants which display the sign “the owner eats here”, this would show the faith of the employees in their product offerings. 

Well, to extend the same analogy, the owners/ employees may be eating what Kotak Mahindra MF offers, but if the data above is anything to go by, their cooks (the fund managers) seem to largely have an aversion towards their own cooking.  Thus, investors are right to be curious, if not suspicious, about what makes the cooks so averse.

PS: One of my collaborators is willing to wager that in the next updation of the SIDs (due for release shortly), the disclosures will show much more investments by the fund managers in the schemes that they manage.  While I don’t want to bet one way or another, if it does happen, I hope it is because of genuine conviction on the part of the fund managers, rather than because of this blog.

May 10, 2018

What I Learnt From Kotak Select Focus

Up until two weeks ago, I knew very little about Kotak Select Focus Fund.  I knew who managed the fund.  I was aware of the astounding growth in its AUM- from just over 300 crore at the start of 2014, it had become one of the largest equity funds in the country.  I also knew that in a few days from now, it would be renamed Kotak Standard Multicap Fund.  But that was all that I knew.  Frankly, I didn’t feel the need to know much more.  Experience and common sense have guided me to stay away from fund houses and schemes that grow rapidly in terms of AUM. 

Then, quite out of the blue, thanks to circumstances too convoluted to describe here, I was compelled to take a closer look at this scheme.  In this post, I present some of the lessons that I learnt in the process.

Lesson 1: Some funds have a strategy, other funds just copy that strategy

In the marketing material of Kotak Select Focus, I saw a strong emphasis on the scheme’s “unique” strategy.  Yet when I examined its portfolio, it appeared that the bulk of the fund’s portfolio was imitating the portfolio of Kotak Opportunities Fund, which had been launched 5 years before Kotak Select Focus.  Going back all the way to 30 September 2012 (the earliest date for which portfolio disclosures with ISIN were available), I could see significant overlap in the portfolios of these two schemes.  The table below gives a glimpse of that.

Kotak Select Focus: Portfolio Overlap with Kotak Opportunities

No. of
% of
% of AUM in
30 Sep 2012 37 65% 78% 73%
30 Sep 2013 43 91% 94% 82%
30 Sep 2014 37 77% 83% 75%
30 Sep 2015 39 74% 79% 70%
30 Sep 2016 39 76% 83% 70%
30 Sep 2017 37 66% 76% 66%

Compiled from statutory portfolio disclosures made by Kotak Mahindra MF.

These numbers are all the more stunning when you consider the fact that in the case of both these schemes, there are very few restrictions on the market capitalization of the stocks that they can invest in.  The fund house could easily have created distinctive portfolios for both these funds yet, for some reason, it chose not to.

So why did the fund house launch Kotak Select Focus in the first place?  Why have they been touting its strategy as being unique?  And if they didn’t have anything unique to offer, then why didn’t they merge the schemes?   I put these and some other questions to the fund house but I am yet to get any answers.   For now, I am inclined to infer that while there was a unique strategy for Kotak Opportunities, the strategy for Kotak Select Focus was to largely mimic that strategy.

Lesson 2: Star ratings and return rankings can be awfully misleading

This is not a new lesson for me: it’s just that after seeing the star ratings of Kotak Select Focus, it was put into sharp focus (no pun intended).

One of the many problem areas with star ratings is the way in which rating agencies classify schemes.  Regardless of a scheme’s investment objective, Value Research and Morningstar have their own view on how to classify it.   What’s more, their classification can change from time to time.  The recent reclassification of Kotak Select Focus by Value Research illustrates the confusion that it can cause.

For most of the scheme’s existence, Value Research classified Kotak Select Focus as a multi-cap fund.  A few months ago, it reclassified it as a large-cap fund.  The impact on its star rating was immediate.  From a 4 star fund, it became a 5 star fund.  That’s because under the new classification, it was compared with large-cap funds (and not multi-cap funds).  Also, its return ranking changed immediately.  For those who find that difficult to follow, here’s a simplified snapshot (using data from Value Research) that may help to explain the difference:

  • As on 30 Apr 2018, based on trailing 5 year returns among large-cap funds (regular), Kotak Select Focus was ranked No.2 (out of 85 funds).  If it had been classified as a multi-cap fund, it would have been ranked No.14 (out of 57 funds).
  • As on the same date, based on 3 year returns among large-cap funds (regular), Kotak Select Focus was ranked No.3.  If it had been classified as a multi-cap fund, it would have been ranked No.24.

Lesson 3: Fund performance can sometimes be very hard to swallow

I have come across countless reports that have praised the “consistent performance” of Kotak Select Focus.  In my opinion, these reviewers have failed to see how utterly extraordinary, exceptional and magical the performance of this scheme has been.  Let me explain.

Let’s take the rolling 1 year returns since the scheme’s inception.  Kotak Select Focus gave higher returns than Kotak Opportunities  about 83% of the time. If you go further and consider rolling 3 year returns, it beat Kotak Opportunities 98% of the time. If you consider rolling 4 and 5 year returns, it beat Kotak Opportunities 100% of the time. 

Now, think about this.  When two funds have such persistent similarity in their portfolios, they have an equal chance of outperforming each other.  So how is it that Kotak Opportunities never beat Kotak Select Focus over any 4 or 5 year period, even once?  From where I come, if something like that happened, it would be considered spooky.  That would be all the more so, given that both funds have had the same fund manager for quite some time now.

But that’s not all.

Kotak Select Focus even outperformed the two large-cap funds managed by the fund house (Kotak 50 and Kotak Classic Equity) over almost every rolling 3, 4 and 5 year period.  What’s even more astonishing is that this included periods over which large-cap indices did better than mid-cap indices and broad market indices.  In other words, Kotak Select Focus beat those schemes even at times when those schemes should have rightfully given better returns.  As one of my collaborators called it, “that’s a gravity defying performance.”  I agree.  That’s nothing short of the stuff you see in superhero movies.

So how is it that this fund has had such a casino-beating winning streak, if I may call it that? 

While I would love to hear what the fund house has to say about that, given the lack of response from them to my earlier questions, I am not sure if I’ll know anytime soon.

Special thanks to Robin Jehangir for his invaluable inputs.

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