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Fund mergers: What mutual fund houses do to hide underperformance

There would be three fund mergers over next two months and all these three schemes have poor performance. Are fund companies opting for fund mergers to hide scheme underperformance?

 
Over the past one year, as many as seventeen schemes have been discontinued and merged into existing schemes. Three of these schemes have been approved for merger since June 2012. UK Sinha, chairman, Securities Exchange Board of India (SEBI), had expressed concerns over underperformance of equity schemes at a mutual fund summit and said that they encourage merging of schemes. However, fund companies should not choose this as the best way out, he added.
 
But one can expect some more mergers in the near future as fund houses prefer to merge their underperforming schemes into larger schemes that are performing better. One of the main reasons why fund companies do this is because once a scheme starts underperforming, other investors would shun the scheme and therefore there would be no fresh inflows, in fact existing investors would start exiting. Take the example of the worst performing fund house—JM Financial—which over the past one year has merged 10 schemes into just three schemes. UTI MF too, which has a labyrinth of schemes, has discontinued five schemes and has merged them in to existing schemes.
 
Many of the schemes that have been merged would have just been fad schemes that were launched during a ‘hot’ period. However, once they got out of fashion and inflows dried up, merger seemed to be the best option. That is why one sees so many sector schemes among the list. We have always warned about sector funds. We have also written that there was nothing ‘contra’ about Contra Funds as these funds fails to live up to their name and objective, ING Contra Fund is one such scheme and has been merged.
 
If a scheme has a bad track record, it would take a long time before it becomes more appealing. Mergers reduce the management costs for the fund house and erase the bad track record. Schemes with a small corpus can cost more to mange than they generate in fees. The plus for investors is that the expenses ratio could get reduced in cases when the scheme which it is being merged with has a much larger corpus. However, what is more important is the performance of the new scheme.
 
If one of your schemes has got or is getting merged, then you may have been invested in the wrong scheme from the start. But if the performance has been reasonable, then probably the merging schemes have similar strategies. Therefore, investors must evaluate the new scheme objective whether it is the same and if it fits into your portfolio.
 
Let’s look at the two mergers that will be executed this August. SBI One India Fund will be merged into SBI Magnum Equity Fund and Principal Services Industries Fund will be merged into Principal Growth Fund. Both these schemes that are being phased out have pathetic performance. In the last thirty three-year rolling periods from 1 January 2007 to 30 June 2012, SBI One India Fund has underperformed the benchmark on 27 occasions and Principal Services Industries Fund has underperformed the benchmark on all but two occasions. Both these schemes have underperformed their respective benchmark by an average of two to three percentage points.
 
The investors of the SBI scheme would be better off in the new scheme—SBI Magnum Equity Fund—as it has underperformed the benchmark just twice and the expense ratio would come down from 2.27% to 2.24%. However, the same cannot be said of the Principal scheme. Other than the reduction in expense ratio, the performance of the new scheme is just as bad, underperforming the benchmark 29 times out of 30. There are better performing schemes of other fund houses which one can choose as well.
 
It is important for investors to keep a track of their schemes and keep an eye open for deteriorating performance. If your scheme begins to underperform its benchmark regularly it is time you switch and opt for better performing schemes.

User

COMMENTS

Nem Chandra Singhal

4 years ago

Good, informative and inspiring article. It may be one of the reasons that the Indian Investor's are not investing in Mutual Funds. It is a black spot on the fabrics of the MF industry, which they should realize as soon as possible, otherwise some of the MF houses like JM will be wiped out. Thanks
Nem Chandra Singhal

Jayant

4 years ago

If distributors do it it is called churning. If AMC's do it then it is called Merging. High time action was taken against errant fund managers for which distributors have taken the blame. A classic example being quant funds which were shown to distributors as funds that could never go wrong irrespective of market conditions, but have grossly underperformed.

Ramesh Poapt

4 years ago

Excellent! Perhaps Equity AUMs of MFs is not solely by market uncertainty,MFs too are responsible for their underperformance!Its a wake up call for the MFs to improve of their own!they will have to work hard with sincerity! Culprit is somewhere in MFs own house!

Hybrid funds: Herd mentality of fund houses continue

Despite the poor response to other similar schemes which have been launched in the past, Franklin Templeton MF and Union KBC MF plan to launch their own hybrid schemes

Franklin Templeton India Allocation Fund and Union KBC Asset Allocation Fund, will offer a mix of equity, debt and gold in their portfolio, according to their offer documents filed with the Securities and Exchange Board of India (SEBI). These schemes offer nothing different from the 19-odd schemes that are already available in the market. The total corpus of these 19 schemes amount to just Rs2,624 crore which is less than the corpus of any one of the top 15 equity diversified schemes. More than half the schemes have a corpus less than Rs100 crore and six of these schemes have failed to accumulate even Rs10 crore. Why has the response been so poor? Underperformance could be one of the reasons.
 

 In our recent analysis, Hybrid Funds: Adding gold did not help , schemes having gold as a part of the portfolio had a lacklustre performance. Just half of them were able to outperform their composite benchmark. Having gold as an investment is risky, apart from this investors have to decide how much they can put in such a fund and how much returns it is expected to generate.
 

These schemes have varied asset allocation strategies as well. For some fund companies the allocation can go up to 60% in gold, whereas, others restrict themselves to a maximum of 20%-35% in gold. FT India Allocation Fund, which is a Fund of Funds hybrid scheme plans to follow a dynamic asset allocation strategy, where, if the fund manger feels he can invest nil or the entire assets in equity funds, debt funds or gold ETFs. The fund manager is free to choose his own asset allocation. So there may be a time when the fund manager may be fully invested in equity if he sees a big opportunity there or he can move entirely out of equity and keep the assets invested in debt or gold or both. This kind of dynamic asset allocation strategy could be highly risky for the investor. The fund proposes to primarily invest in domestic equity, fixed income, liquid schemes of Franklin Templeton Mutual Fund and domestic gold ETFs.
 

Union KBC Asset Allocation Fund will be offering investors two different plans. The aggressive plan would invest 55% to 75% in equity, 5% to 25% in debt and up to 20% in gold ETFs. The second plan, which is the conservative plan, will have a lesser allocation towards equity (15% to 25%) and more towards debt (55% to 85%). The allocation towards gold ETFs will remain the same.
 

Hybrid schemes, especially those that have gold as a part of their portfolio, are best avoided. The returns of these schemes have been erratic in the past. But if one is looking for capital appreciation, which is the prime investment objective of these schemes, investing in pure equity schemes would be the best bet for a long-term investment. But where is gold headed, no one knows. Hybrid schemes are too risky for the short-term and do not look too promising for the long term as well. If one is looking to invest for the long-term, keep it simple, choose an equity scheme with consistent performance.

 

Scheme details:
 

FT India Allocation Fund
 

Benchmark: 25% S&P CNX 500 + 25% CRISIL Short Term Bond Fund index + 25% CRISIL Liquid Fund index + 25% Gold domestic prices
 

Expense ratio: 2.50%
 

Exit Load: 1% if redeemed/switched out within 1 year of allotment

 

Union KBC Asset Allocation Fund
 

Benchmark:
 

Aggressive Plan: 70% S&P CNX Nifty + 15% CRISIL Composite Bond Fund Index + 15%  CRISIL Gold Index
 

Conservative Plan: 15% S&P CNX Nifty + 70% CRISIL Composite Bond Fund Index + 15% CRISIL Gold Index
 

Expense ratio: 2.25%
 

Exit load: 0.50% if units are redeemed/switched out within 6 months from the date of allotment; Nil thereafter.

User

COMMENTS

Nem Chandra Singhal

4 years ago

Well said about hybrid funds. Most of the Indians own gold in its physical forms. Most of the Indians, particularly, ladies will have more than 10 % their assests in gold. Basically, Indian are gold hungry as the faith on the paper assets are not strong than on real/ physical assets. Hence, the equity MFs are only to be subscribed by the average person.

Ramesh Poapt

4 years ago

Hybrid funds too risky in the short term?surprising!If it is risky equity funds can b double risky than hybrid ones in short,medium,long term!As at 30-6-12,5 yrs return in nifty is 4.09%, in Balanced fund it is 4.55% and in MIP it is 6.17% i.e. Balanced is better than Eqty and MIP us better than Balanced category!On account of uncertain national and global factors for next two years,your above view is not correct.Even investors who are not conservative,should consider above category for proven schemes like HDFC Balanced.Gold option looks compulsion in the present scenario,and may not be that bad!Yes, fund or fund concept is not palatable as FOF is not taxfree like Eqty,Balanced scheme.

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