January 11, 2015

The 32,000 Crore Question

The number in the title refers to something I mentioned in a recent post on my other blog.  I said in that post that there were 80 actively managed equity schemes that had given lesser returns than the NSE-50 over the seven year period from 8 Jan 2008 to 7 Jan 2015 (the NSE-50 TRI grew by 4.87% p.a.), and that currently there was Rs.32,000 crore invested in these schemes.  I also pointed out that 22 of these schemes had shown negative returns over this period, despite the upsurge in the stock markets over the last several months.  Finally, I said that while it would be unfair to draw any sweeping conclusions based on these facts alone, the performance of a number of these schemes (if not all) was definitely questionable.

So, what’s the question?

Actually, there is more than one.

What gives fund houses the right to charge fees for poor performance?

Other than a few exceptions, the current expense ratios of most of the 80 schemes range from 2.3% to just over 3%.  I don’t have the historical expense ratios or the breakup between expenses and fees.  However, if I consider the current expense ratios as representative of the historical ratios, then it appears that 42 schemes, managed by 19 fund houses charged more expenses over this seven year period than the return generated by the scheme.  If we were to consider loads, then those numbers would go up.

Why do fund houses launch new equity funds if they cannot meaningfully manage the ones they already have?

Let’s leave aside the thematic/ sectoral schemes.  There were 48 open end, domestic, diversified schemes that gave lesser returns than the NSE-50 over the 7 year period mentioned.  Of the 23 fund houses that managed (or mismanaged?) these schemes, 14 fund houses launched an additional 50 domestic, diversified equity schemes in 2014.  4 of these fund houses had the audacity to launch 18 schemes that had remarkably similar investment objectives to the ones managed by them, and whose performance was questionable. 

Most investors do not have the understanding to ask these questions with the supporting facts that I have laid out here.  That doesn’t mean that investors don’t understand that something is not right.  As I pointed out in an earlier post, there is evidence of a lot of hate for mutual funds, and fund houses would do well not to underestimate that.  Not everyone takes the view that comparisons are best made with proper benchmarks; for most investors the natural benchmark is the returns on a fixed deposit.  Thus, to most investors, the picture is a lot grimmer, and grimier than what I have presented here.  The mutual fund industry needs to address these issues in a far more better, and responsible manner than it has done so far.

The industry may also want to think about the fact that this is not an issue restricted to equity schemes alone.  Over the same 7 year period, 62 (out of 87) debt schemes in Value Research categories, Debt Income, and Debt Gilt Medium & Long Term , gave lesser returns than a 7 year deposit with SBI.  The current investments in these schemes are in excess of Rs.40,000 crore.

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