Fund companies float NFOs when the market is hot. This usually leads to poor returns for years
Fund management is a business. Fund companies make money on the money they are able to collect from the public through existing and new funds. Because of investors’ ignorance and lack of adequate regulatory oversight, fund houses prefer to launch new schemes in different flavours whether investors need them or not. They time their launches when the market is hot. This usually leads to poor returns for years.
One of our parameters for ranking fund houses is their greed to raise fresh funds from the public as reflected in their hurry to launch NFOs during rising market cycles. To get the public’s interest and attention, fund companies come out with funny NFO ideas, sold under various marketing gimmicks with incentives for distributors. Many of these ideas are untested and unproven. Moneylife has been consistently critical of NFOs and, not surprisingly, most of the NFOs took very long to deliver returns—if at all. This is a peculiar phenomenon, to capture which we have aggregated NFOs launched by fund houses timed with a strong market uptrend. We have identified seven such uptrends in the past five years. Among those that have rushed to raise money from investors during peak market cycles were: Reliance Mutual Fund (RMF) and Sundaram Mutual (27 NFOs each), ICICI Prudential Mutual Fund (20 NFOs) and Birla Sun Life Mutual Fund (19 NFOs). Notice that Fidelity and HDFC have achieved top honours without launching too many schemes, while DSP BlackRock Mutual Fund, another top fund house, launched a moderate number of NFOs. The exception is RMF, which has managed high returns and stood first among all the other funds, even though it has brought in a large number of NFOs timed with a strong market rally.
Our study covers a period of five years which have been excellent for Indian investors and for the fund industry. The number of fund houses operating in India has gone up to 41 (from 37) in the past three years. However, for this study, we have considered fund houses with equity assets of at least Rs1,000 crore that have been operational in the Indian market for more than five years. This left us with only 19 fund houses to rank. The ranking was based on four factors.
The first factor is the average performance of equity growth funds which have been in existence for more than five years. This gave us 146 equity growth schemes of 19 fund houses in three categories—diversified, sector and index funds. We calculated the average returns provided by them during the past five years and annualised them. We then took the average of such returns provided by the various schemes of each fund house to arrive at the average return for each fund house. This yielded the performance rank.
Second, we believe that returns are just one part of the story and equity investors must be concerned about losses as well. This is captured by an average of the Sortino ratio for schemes offered by each fund house, which gave us the measure of the downside risk associated with each fund house. This was aggregated and averaged for each fund house and was ranked again. The Sortino ratio allows investors to better assess the risk. It is a variation of the Sharpe ratio which captures all volatility. Sortino separates downside volatility from volatility in general.
Third, we ranked fund houses by the number of NFOs offered by them when the going was good (periods of rising markets). We have provided negative weights for NFOs—the more the NFOs, the lower is the rank.
The fourth factor that we considered was the size of assets managed, as of December 2010. The larger the size, the better; to some extent, this reflected the acceptability of funds among distributors and investors. We weighted each of these four parameters and arrived at a composite rank based on them. This gave us our final list of best fund houses. We have changed the ranking values this time. We have ranked the schemes on a scale of 1-19, instead of ranking them on a scale of 1-100. This has yielded more accurate relative ranks.
Noshir Dadrawala, chief executive of the Centre for Advancement of Philanthropy, discussed the...