Selecting an equity mutual fund is a pain in the neck! Find out why?

Selecting a decent equity mutual fund to build a portfolio was always confusing and difficult.

Unfortunately, in recent times, there have been certain changes due to which fund selection has become even more difficult.

Let us explore each of these in detail and also find out if there is a way out of this mess.

Problem No 1: Fund Managers and the game of musical chairs

In last few years, thanks to the bull market, a lot of fund managers have moved across fund houses and a few of them have even moved out and opened their own investment firms.

Sample this:

• Kenneth Andrade who was the CIO of IDFC Mutual Fund left in 2015 to start his own Investment firm Oldbridge Capital
• Anoop Bhaskar replaced him as he moved from UTI to IDFC in 2016.
• Vetri Subramaniam (earlier the CIO in Invesco Mutual Fund) in turn replaced Anoop Bhaskar as the CIO in UTI
• Taher Badshah who was the fund manager at Motilal Oswal has replaced Vetri Subramaniam as the CIO of Invesco mutual Fund
• Pankaj Murarka who was the head of equities at Axis Mutual Fund quit to start his won firm Renaissance Investment Managers
• Sudhanshu Asthanah who was a senior fund manager in Axis Mutual fund quit to start his own firm Tamohara Investment Managers
• Shreyas Devalkar – the fund manager in BNP Paribas Mutual Fund has moved to Axis Mutual Fund
• Gopal Agrawal, the CIO of Mirae Asset Mutual Funds quit to join Tata Mutual Fund – Now recently a Gopal has also quit Tata Mutual Fund!
• Vinay Paharia – the fund manager in Invesco left to become the CIO in Union KBC Mutual Find
• Ravi Gopalakrishnan – head – equities, resigned from Canara Robecco Asset Management Company
• Sunil Singhania, the CIO of Reliance AMC also quit last year to start his own firm – Abakkus Asset Manager LLP
• Manish Gunwani a fund manager at ICICI Prudential Mutual Fund quit to become the CIO in Reliance Mutual Fund
• In DSP Blackrock Mutual Fund there have been a lot of changes in recent years
  • Anup Maheswari the CIO quit recently
  • S. Naganath, the erstwhile president and chief investment officer at the fund house left in May 2017
  • Apoorva Shah, the previous fund manager also moved out of the domestic mutual fund unit to the fund house’s offshore division

Phew, my head is already spinning 🙂

Anyway the simple point is that, for most of the funds where the fund manager has changed, the existing track record becomes irrelevant while choosing the fund.

The fund houses will (obviously) argue that they have a robust investment process and a change in the fund manager will not have an impact, but I think it would be extremely naive of us to believe that.

All said and done, in my opinion, a fund manager is the biggest factor responsible for the returns from a fund. (Think Warren Buffet,  Charlie Munger, Ray Dalio, Howard Marks, Seth Klarman, Peter Lynch etc)

Problem No 2: SEBI and its new fund categorisation rules

In the recent past, the regulator The Securities and Exchange Board of India (SEBI) had rightly come to the conclusion that Asset Management companies had too many funds and there was no common definition for categories leading to significant confusion while selecting funds for investors.

So in October 2017, SEBI, called for the rationalization of mutual fund schemes and defined various categories of funds, along with the scheme characteristics for each fund category. (see circular for categorization and rationalization of mutual fund schemes).

It brought down the list of categories under equity mutual funds to 10.

Source: FundsIndia

And to avoid duplication, SEBI has also mandated that each fund house can have ONLY ONE scheme in each category.

As a result of the above changes, many mutual fund schemes are either being renamed, recategorized or merged/ terminated. This whole revamp is expected to get completed by June-18.

If interested, the summary of the entire changes can be found in Funds India website here

Thus adding to our existing problem of several fund manager changes, the recent SEBI fund re-categorization, has also made the historical returns of several funds (where there is a dramatic change in mandate) irrelevant.

Thus if you are someone who picks funds only based on past performance or other quantitative metrics then please remember that for many funds the past returns and metrics may not be relevant anymore.

Also I have earlier discussed here and here as to why past returns are not a great way to pick funds. I usually check for

1. Consistency in performance across market cycles versus peer group and benchmark
2. Downside risk via capture ratios
3. Fund Manager – do I understand the investment philosophy, process and does he/she stick to it

Given the context of recent changes, consistency and downside risk measurement based on past returns would be irrelevant for many funds going forward.

Thus the key to select funds will be to understand the fund manager, his investment philosophy, investment process, ability to stick to his process and track record.

Herein lies the third problem..

Problem no 3: Lack of communication

Unfortunately unlike the global fund managers, the level of fund manager communication in India via (newsletters, memos, updates etc) is extremely poor or rather non-existent. The only source for normal investors is their public interviews.

However, majority of the fund manager interviews in public magazines and websites are literally indistinguishable from each other.

Barring a select few, most of the interviews are a common script which will include a mix of fancy words such as – high quality business, decent cash flows, decent ROEs, scalable opportunity, sustainable competitive advantage, pricing power, right to win, reasonable valuation, growth, top down, bottom up, good management blah blah

If you don’t trust me, you can check a collection of interviews here..

• https://www.morningstar.in/posts/collection/interviews.aspx
• https://www.valueresearchonline.com/story/archive.asp?sec=62

This essentially means its a struggle from our side to find out what is the underlying investment process and philosophy. So if in case the fund under performs in the interim (which eventually happens), there is no way we will be able to hang on with conviction.

And unfortunately as evidenced by this vanguard study in the US (click here to read the study), even the best funds went through under performance vs their benchmark in at least five years of the 15 year period for which the study was conducted, and 60 percent had at least seven years of under-performance. Further two-thirds of them experienced at least three consecutive years of under-performance during that span.

This implies even good Indian fund managers will inevitably go through periods of temporary under-performance where their style is out of favor or they make some mistakes.

Lack of  communication on what is happening implies we will bail out of the fund as returns are the only parameter communicated to us!

Oops! We have a huge issue..

Thus for all of us looking to pick a few funds and build our equity portfolio we have three issues

1. Significant fund manager changes in recent times
2. SEBI’s new scheme re-categorisation leading to change in mandates for many schemes
3. Lack of communication from fund managers

Not all is lost..

While I have painted the whole industry with a broad brush on the lack of communication, there are a few exceptions where the communication has been good or has started to improve in recent times

1. PPFAS : These guys are by far the best and are way ahead in terms of their communication
   • You tube channel where they discuss various insights on behavioral finance, industry trends, investment process etc  https://www.youtube.com/user/ppfasltd/featured
   • They have an annual shareholder meet where they discuss their portfolios: https://www.youtube.com/watch?v=hrRLx-s1xsg
2. Motilal Oswal : They have a good website and have clearly communicated their process
   • https://www.motilaloswalmf.com/blogs/chairman-speak
3. DSP Blackrock: Recently the level of communication from the fund house has significantly improved
   •  Fund and Strategy communication: Insights
   • A detailed note on DSPBR Opportunities fund: Link
4. Quantum: While the website is a little clumsy and outdated, you can find decent communication about their process
   • https://www.quantumamc.com/
5. IDFC: Recently the communication has improved. Especially on their flagship product – IDFC Core Equity Fund (Link)
6. ICICI Prudential Mutual Fund – The details on the website is still not that great. But there are frequent interviews of the CIO Sankaran Naren from which we can get a sense of their investment philosophy and process
   
   • You can check my earlier post on this here
7. UTI: Again a recent move in terms of improving communication
   • https://www.utimf.com/articles/?filter-type=category&filter-value=blog

So while fund selection has become more complicated, the fact that some fund houses are improving their communication means we can still work around and build our portfolio.

In my next post I will explain my thought process on how I would go about selecting funds for my portfolio.

Till then, happy investing as always 🙂

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