Mutual funds in 2000 -- Dent in credibility

S. Vaidya Nathan

IT HAS been a bad year for mutual funds -- debt and equity.

Only one category of funds did well -- the treasury management funds and the money market funds which invest in short-term debt instruments. These funds are essentially targeted at corporate sector and other high net-worth individuals.

At the end of the day, the debt funds targeted at retail investors did not deliver the goods. The equity funds expectedly did badly given the over 20 per cent decline in the broad market and the steeper declines in the information technology/media/telecom (TMT) stocks. SEBI has also been active in making improvements in the regulatory framework and, by and large, it has moved in the right direction. So has the Association of Mutual Funds of India (AMFI) in the area of dissemination about fund mobilisation and NAVs.

Poor debt story: But the debt fund story should cause concern. Forex market volatility and monetary tightening by the Reserve Bank of India are likely to be a once or twice yearly feature.

If mutual funds as a class are going to be caught out and suffer steep losses at such times, it could mean they are not able to deliver returns that are superior to other fixed income options. If the treasury management and money market funds escaped a mauling it was mainly because they invest in short-term money market instruments, where the going was good, when the RBI tightened the belt.

The galling aspect is that almost no fund anticipated these moves. If this is repeated for a year or two more, mutual funds may find the going tough in attracting retail investors to their debt schemes. As it is, the imposition of a 20 per cent dividend tax (plus surcharge of 10 per cent) has cut into the returns of all retail investors, especially those in the 20 and 10 per cent tax brackets.

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Familiar new fund story: The bullish phase in the stock market in the first quarter of 2000 -- with the TMT stocks in the forefront since September 1999 -- saw mutual funds rush in to sell newer and newer products. And virtually all of these funds (with the possible exception of Alliance New Millennium to some extent) are in a miserable state.

A recovery to par ground may take time and could be difficult. This is a very familiar story. Mutual funds are going all out to sell new products and solicit funds from investors when the market is in a major bull phase. The argument cited in support is that this is when they can sell funds easily and find takers. This happened in 1992, 1994, 1995 and 2000.

And on each of these occasions, investor confidence had taken a knock. The funds also took at least three years to recover, if at all they did. The story in 2000 may not be very different. Even if it means a lot of patience, mutual funds may be better off avoiding seeking funds while riding on the back of a big bull run. They are probably effectively selling lemons to shareholders.

Selling a lemon: This is precisely what the Unit Trust of India (UTI) is doing with its flagship fund, US-64. Despite the fact that the underlying asset value of the fund is below the sale price and the scheme is slated to move into a NAV-based system a year down the line, the UTI has continued to aggressively market the product.

It has adduced features that are non-existent and not portrayed the right picture to investors. Of course, this is nothing new, as the UTI has been following a similar path for some years now. All investors who have bought in into the scheme would be staring at up-front losses.

And the returns offered by the scheme -- in absolute and risk-adjusted terms -- continues to be abysmal. SEBI and the Government must step in soon to stop this `marketing removed from reality' by the UTI.

Herd mentality: In terms of asset management, fund managers have shown a high degree of herd mentality in sectoral as well as stock selection. To some extent, this may be justified by the narrow universe of stocks on offer. But few funds have shown a consistent strategy.

Barring Kothari Pioneer, Sundaram Mutual and Alliance Capital, most other funds were active traders. It may be argued that an active approach is needed in the Indian context to make money. There is no doubt about that. But many funds have been trading in a way not too different from day-trading. And not one of them have the numbers to back up such a strategy, which is not surprising.

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A spectacular fall: One other fund that followed a consistent strategy is Birla Mutual Fund, though little has gone right and its schemes have been among the worst performers. Unfortunately, there is no satisfactory explanation for such a showing from a fund that, till 2000, was one of the best performers. If such a fund comes apart, the fund managers owe investors a better explanation than what has been forthcoming from Birla Mutual Fund so far.