A few readers responded to my last post and their observations and thoughts made the case for this post. It would help to have read that post before reading this one.
One reader found it “highly unusual” that the fund house in question chose to replace its index fund with Amazing Quant Fund and then re-launch the index fund a couple of years later. He also noted that because its objective allowed the fund manager to freely pick 15-20 stocks from within the NSE-50, its performance relative to their own NSE-50 index fund was an accurate reflection of the capabilities of the fund manager and perhaps, even the fund management team. He suggested that any success that they may have had with other funds could well have been because of luck.
I, too, see immense merit in comparing the performance of Amazing Quant Fund with that of the NSE-50 index fund offered by the fund house. The only challenge in this case is that it is not clear as to what extent is the portfolio construction attributable to their model versus the fund manager’s expertise. As the fund house puts it, “final selection of stocks and weightage allocation is a composite effort of the Fund Manager and the quantitative model”. Nevertheless, I feel it safe to presume that the fund management team would have had faith in that model for it to be used (they may even have had a hand in designing the model), and hence the credit or blame can be rightfully placed at their doorstep.
Based on the evidence so far, it seems they have a lot to answer for. As I mentioned in that post, in each of the last 5 calendar years, Amazing Quant Fund has given lesser returns than the index fund. If we slice this further, it has given lesser returns over 11 of the last 16 quarters, and over 31 of the last 49 months, with no discernible edge in either up markets or down markets. A track record such as that clearly questions the strength of the model and/or the fund manager’s expertise.
But why would such a fund continue to be in existence, and what would explain its massive AUM relative to the index fund? Picking on this point, as I posed it at the end of that post, one other reader, a fund investor from Dehradun, offered some insights. He was able to accurately identify which fund I was referring to, and he clarified that the vast difference in AUM between the two funds was because Amazing Quant Fund had offered a significant dividend-stripping opportunity last June (something I had overlooked). He also took time to pen his thoughts on the ethics of fund houses. I reproduce his email below:
Reference to what you wrote in the last line "Maybe they cannot see the facts for what they are." To me, in this case, it's the opposite and the distributors saw what others could not see and sold this scheme to investors who needed this when it was most beneficial to them. This fund helped investors in dividend stripping by announcing huge dividend which attracted around two thousand crores by investors who wanted to save taxes, just by creating notional loss. To my mind, every element of this – choice of an index linked scheme with very small AUM; best suited to manage a huge dividend declaration; being just 9 and half month before the end of financial year – is all very carefully planned and sold. The money, most likely if properly hedged, shall exit the fund around last week of March 2016; the investors shall use this notional loss to save tax by offsetting gains in this or coming many years. Now, one may ask why would someone take so much of risk to manage tax. The answer lies in the choice of this fund- quant (index). This loss can be hedged by using nifty futures.
This is also a way to show normal income to repatriate money beyond the RBI permissible limits from NRO account.
It is sad to see how mutual fund schemes, which are meant to be for the sole interest of investors, being used by the managers of these schemes (read, the AMC) to earn money for themselves. Earning money is no crime and I would have no worries if this earning money is done by ethical means. However, use of mutual fund scheme as a vehicle to help a section of investors (read, the HNI’s) save tax or to transfer wealth out of India? This raises the following questions in my mind:
- How can I trust a mutual fund with my money? Now, this is not about doubting the structure of mutual fund - trustees, custodian and auditors - which are present to safeguard my money. This is about something deeper- conflicting interests. The interest of AMC lies in more AUM resulting in more Fees. The investor interest lies in ethical practices which may not allow easy inflows in the short term, at-least for weaker AMCs. While, operation systems and checks can help safeguard my money from external threats, how effective can they possibly be if the AMC indulges in legally correct but unethical tendencies. If an AMC can launch a scheme for the benefit of some people to help them circumvent law and save taxes, what stops them from changing their fees after I invest my money in the scheme? What stops them from charging less fees when a big corporate enters in the scheme and from charging more after its exit?
- What am I supposed to think about the independent trustees who allowed the Index scheme to be changed and then again new index schemes to be launched?
- What faith should I have in a regulator who may have witnessed this all silently?
- What am I supposed to expect of the financial advisors? Investor interest matters the most or distribution fees matters the most? If indeed, investor interest matters the most, then is that interest safe with an AMC with highest returns or with an AMC with most ethical practices?
- As an investor, what should I give priority to while committing to an investment plan? The comfort of past performance of an AMC or the comfort of their ethical practices?
Now that should give SEBI, AMFI and the fund houses something to think about. As for me, I put my thoughts on selecting a fund house here. And I am glad to say that this fund house doesn’t make the cut for me.
