May 15, 2015

The Notion of Pushing Equity Funds

“Mutual funds are sold, not bought.”
“Mutual funds are a push product.”

These are statements that I’ve heard quite often, usually to justify high payouts to distributors.  Over the past few months, these were being thrown around to make the case against the cap on distributor commissions.  Frankly, to me, such assertions fall somewhere between pseudo-intellectual babble and oversimplification.  Don’t get me wrong.  While I don’t think it’s easy to generate mass appeal for mutual funds in India, I believe that it is the inane push-strategies, particularly in relation to equity funds, that are primarily responsible for the current ambivalence of investors.  As I see it, the question to be asked is this: does it really make sense to have a push-strategy for equity funds?  In this post, I offer my thoughts.
Leave aside those who understand the risks in equity investing.  Most Indian investors regard investing in an equity fund as worthwhile only if they can get better returns than a bank deposit.  While many are able to live with a fund somewhat underperforming a bank deposit, practically no investor is willing to accept losses, or significant underperformance, on a fund that they have held for ‘long enough’.  Obviously, perceptions of what is a long enough period vary.  In a closed-end fund, nearly all investors deem the tenure of the fund to be long enough.  In an open-end fund, there is no such consensus.  My experience is that nobody disputes a period of 7 years or more as being long enough.
So, what are the chances that these expectations will be met?  If historical data from Value Research is anything to go by, one out of every three closed end equity schemes has been redeemed below par.  A number of these were 10 year schemes.  Most schemes were redeemed at discounts of 20% or more, some in excess of 50%.  Though data from open end schemes cannot be summarized in a similar manner, if you consider performance from the peak of the last bull run, to the present (7 years 4 months), about one-third of all equity funds have given a return that is less than half of what one could have got by investing in a bank deposit with SBI (without accounting for taxes).  In fact, one out of every four of these funds is currently below the NAV of that peak. 
In short, there is a very real possibility that an investor in an equity fund could end up being disappointed.  That’s not all.  Depending upon the persuasiveness with which a scheme is recommended, and the extent to which an investment in it falls below expectations, an investor could be angry, even hostile, towards not just the fund house behind the scheme, but mutual funds per se.  In this backdrop, a push-strategy becomes a questionable exercise unless it can be executed in a manner that keeps expectations in check.  Right away, I can think of some advisors who excel at that.  Their emphasis is on pushing the clients to save and invest for their long-term goals.  They sell equity funds not as a product, but as a solution that, notwithstanding its risks, has no alternatives.  I am sure there are other advisors who would be doing something similar.  However, for a fund house to do so is far more difficult, if not impossible.  Thus, when I see fund houses pursue push-strategies, I am not sure what gives them the confidence.  In fact, I am baffled by some of the strategic choices made by fund houses.
To take an example, most fund houses promote equity funds with great fervor during bull phases.  New funds are launched, and distributor commissions are hiked.  While I accept that investors are most responsive to buying equity funds during such periods, it is equally true that by investing at such times, the odds of a client’s expectations being exceeded, are considerably diminished.  This risk is enhanced by the fact that among the distributors employed by fund houses, peddlers significantly outnumber advisors.  This would not necessarily be a bad thing if these peddlers were restricted to selling simple products such as liquid funds or FMPs.  Instead, fund houses induce them to sell equity schemes, and, as in the past year, closed-end equity schemes, the risks of which, most of them have little understanding of.  Worse still, among them, there is a growing breed of individuals, most visibly employed in banks, who don’t even care about their lack of understanding, and what harm this could cause their clients.  Someone I know, likes to refer to these individuals as suicide bombers.  I think a more appropriate analogy would be with suicide bombers who invite their target to their own apartment in a multi-storey building. 
The problem, thus, is not in having a push-strategy- it is in allowing anyone to push any fund in any manner. 
I frequently liken equity funds to strong medicines.  Just like strong medicines, these work best when prescribed.  And under no circumstances should these be peddled.
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