For whom the Dice Rolls

If and when asset management companies are listed, sell all your funds and buy the stocks of AMCs! Here is why

This magazine has repeatedly proven that a large number of funds underperform their respective benchmarks. Intensive fund tracking in the US spread over the last 40 years reveals that 80% of actively managed mutual funds have underperformed the market indices. This is why investing in index funds in the US has been a better bet over longer time periods. This is the reality in India too as MoneyLIFE has been highlighting. But who has any interest in pointing out this reality of the fund marketplace? Certainly not the fund companies who want to sell new funds in new flavours based on their supposed stock-picking prowess. If they aggressively sell index funds, it will mean admitting that fund managers’ salaries running into crores of rupees and crores more spent on advertising and sales promotions and all those new fund gimmicks are not worth the money and effort.

Among the many reasons for the below-par performance of funds, the main one is the clear conflict between AMCs’ interest and that of fund investors. Fund management is a business and the earnestness or good intentions of fund managers can never cover up the fact that the dice of returns is loaded in favour of the AMCs. Here is how:
Your Cost: Almost all the costs of running a fund come out of  investors’ money put into the fund -- marketing, advertising, salaries and overheads, the works.
Their Process: To run your fund, the AMC appoints a fund manager who may or may not be specially skilled in stock picking and market timing (yes, market timing is important for superior fund performance).

Your Risky Returns: If you are lucky and if the market is rising, your fund will make money for a while and beat the index for a while. Most of them will not beat the benchmarks and it is usually not easy to know in advance who the winners will be.

Their Safe Returns: The important thing to note in all this is that the business of fund management is completely independent of the performance of funds! No matter how the funds perform, the AMCs make a return of over 1% on the assets they manage. This means that the more the assets they manage, the higher are their earnings. Is it any wonder that fund companies are continuously coming out with more and more ways to raise money? Indeed, the chairman of UTI,  UK Sinha, has publicly labelled other funds as “asset-gatherers” after they raced to the top slot on assets under management.

Think about it. While your returns are under market risk, their returns are safe, a fixed percentage coming out of the funds they manage for you, no matter how badly they do. The regulation does not allow fund companies to charge more or less depending on their performance. This dim-witted socialistic idea lies at the heart of capitalism!

If the cost and revenue structure of the fund management business creates an even stream of safe returns for the AMCs and uneven stream of risky returns for the fund investor, which side of the fence would you rather be?

Given a choice, you would rather be an investor in the AMC and not an investor in the fund! But would this strategy have worked in the US, the only country with a really long-term record of fund management business?

Yes, it would have. In fact, buying the shares of asset management companies would have been very profitable. Most of these companies have seen a steady rise in sales and earnings, and some have enjoyed spectacular, returns, far above the market indices and the returns fetched by the funds under their own management!

Some major fund families, such as Fidelity and Vanguard, are privately held but quite a few fund companies trade publicly. The list includes giants such as Franklin Resources (which runs the Franklin Templeton funds) and Janus Capital Group both listed on New York Stock Exchange and T. Rowe Price listed on Nasdaq.
The stock of T. Rowe Price is up 29% in the past year, and 192% over the past five years. It has a huge operating margin of 44% and a sales growth rate of 22% - one of the highest in the industry. As we said, good fund companies are great sales machines, relentlessly gathering assets. Franklin Resources had an operating margin of 33% and a sales growth rate of 18% last year. The stock is up 27% over the past year, and more than 200% in the past five years. The net profit of fund family of US Global Investors (listed on Nasdaq) has doubled in the September quarter. It is famous for its natural resource funds, but has now cleverly diversified into equity funds. Its US Global Resources Fund and Eastern European Fund (EUROX) are both up 9.07% and 12.27%, respectively, in one year. But the stock of AMC itself is up 386%!

Unfortunately, this strategy cannot be implemented in India for two reasons. One, the fund management business in India was down in the dumps for many years. It has high overheads and does not break even  with an asset size of less than Rs10,000 crore. Only a few funds have reached this level of fund size and may have started to break even. With the winds of demographic change and rising prosperity favouring them, they have now started to emerge as significant asset-gatherers. Once past the break-even point, they will make tonnes of money. While we are sure of this, we are not sure of when they will list their shares. But if you ever find any of the large AMCs like Reliance, Pru ICICI, DSP Merrill getting listed, sell their funds and buy their stocks. You will be on the right side of the game and do far better than the best perfoming funds - even the index funds!

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