In the desire to beat benchmarks, many mutual fund schemes end up adopting strategies which do not work well in the long run
Mutual funds, as a popular investment vehicle, are often projected as panacea for investment requirements of individual investors. Since individual investors lack skills to invest directly in the market and have limited ability to manage vagaries of market movements, mutual funds become natural investment option for investors opting to invest in equities and some other complex asset classes. It is expected that mutual funds are professionally managed, reduce risks and offer returns which are should not just be able to beat inflation but be good enough to provide handsome return. It is because of these reasons that mutual funds are scrutinised extensively for their performance. Running a mutual fund is not an easy job. Over the last six years, especially post-2008 crisis, mutual funds have undergone microscopic examination and have experienced mass exodus of retail investors.
So what is it that makes the job of a mutual fund difficult and where does the challenge emanate from? There is more than one factor which poses challenges for the successful existence of a mutual fund. Here is an analysis of some of these factors:
Too many mutual fund schemes chasing too few quality stocks
As per AMFI (Association of Mutual Funds of India) data for the month of November 2013, there are 293 schemes of equity mutual funds in India. There is no doubt that these schemes cater to different requirements. While some funds are sector funds, some are large caps and some funds focused on mid-cap stocks. But the most relevant question here is: “do we have too many good companies in India?” In other words, do we even have 293 companies listed on stock exchanges which can be classified as investment worthy? The answer would be a firm NO. It is true that one mutual fund scheme requires only 20 to 30 companies for investment but with so many schemes of one single mutual fund around, it becomes challenging for a mutual fund managers to invest differently. Many mutual funds have ended up investing in such companies which have failed miserably and have given below average return. This has adversely impacted performance of mutual funds.
Inability to create product differentiation
For the reasons best known to a mutual fund house, many new schemes are created even when existing schemes are difficult to manage. More schemes mean challenges of product differentiation. It is often difficult to differentiate two large cap funds. The need for differentiation results into wrong stock selection or in some cases concentration of fund portfolio into selected stocks only. Nifty and Sensex stocks dominate most of the large cap funds with weightage of stocks being the lone differentiator. For an investor also, it becomes difficult to select one mutual fund from many similar types, unless a particular scheme has a past which shows that the scheme has done well.
Pressure to outperform benchmark indices
Recently one leading mutual fund came out with an advertisement on the first page of The Economic Times, claiming that all its equity schemes have beaten the benchmark index in a five and and 10 year periods. This shows how important it is for a mutual fund scheme to beat the benchmark index. Since comparison with the benchmark index is often seen as the barometer of the performance of the fund, mutual fund schemes put all their energy into beating an index. It is pertinent to note that while an index like S&P BSE Sensex is a passive entity, a fund manager gets all the opportunity to churn portfolios to beat the benchmark index. Still, many schemes fail to beat the benchmark index. In the desire to beat the benchmark index, many schemes end up adopting strategies which do not work well in the long run.
An investor generally feels that a mutual fund scheme will take care of his financial requirements of wealth creation. But in the current scenario, selecting a good mutual fund scheme has become as challenging as selecting a good stock. Proliferation of multiple schemes of mutual funds has created a dilemma for investors. While investment in schemes of a mutual fund is a good idea for sustainable wealth creation, selecting a good mutual fund has become the biggest challenge for an ordinary investor. Needless to say, this comes from the difficulties that mutual funds have created for themselves.
(Vivek Sharma has worked for 17 years in the stock market, debt market and banking. He is a post graduate in Economics and MBA in Finance. He writes on personal finance and economics and is invited as an expert on personal finance shows.)
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