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Are you married to your fund manager?
October 28, 2003 10:14 IST
Over the past 12 months or so, the domestic mutual fund industry has seen some consolidation. While this in itself is good for the industry, the spate of acquisitions has left the retail investor wondering whether a change of guard in fund management will make his mutual fund investment better or worse off than earlier.
Let us first assess the fund manager's role in a mutual fund (be it debt or equity). To put it bluntly, the fund manager is the individual whose investment style and decision-making dictates the fortunes of the fund. He is the individual who is responsible for the performance of the fund, which in fact is his mandate – to ensure the fund performs.
So the fund manager is the be-all and end-all of the mutual fund? The reply to this question varies from fund house (or Asset Management Company) to fund house. Some fund houses give a free hand to the fund manager even if his investment style (huge stock/sectoral bets, large scale churning, mid-cap/small cap investments) seems incredible to the investing community. On the other hand we have some fund houses that follow a strong, process-driven investment style and the fund manager's role is to perform within the parameters defined by the fund house.
From the retail investor's perspective, investing in a fund house that pursues a process-driven investment style is safer than investing with a fund house that has a very 'independent' fund manager. In an interview with Mr. Prashant Jain (Head-Equities, HDFC Mutual Fund), a leading equity fund manager, we asked him about how much significance could be attached to a change in the fund manager. Mr. Jain asserted, 'Fund managers are important, but not indispensable. By following a disciplined investment strategy and by having processes that ensure risk control, the risk of a change in the fund manager can be mitigated to a large extent.'
Of course, what Mr. Jain has hinted at (about process-driven fund management) is the ideal scenario, which is rarely the case in the mutual fund industry. Several fund houses do not have a definite string of processes in place that define their fund management style. Or if they are processes in place, they are rarely adhered to. Mr. Jain concurs, 'I think broadly the criteria are the same for most funds, differences are there in application.'
Consider a fund house like Alliance Capital Mutual Fund where the outgoing fund manager (Mr. Samir Arora) had a relatively free hand in running the funds. Investors who have got used to his aggressive style of fund management are now concerned if Alliance Capital Mutual Fund will be managed in the same manner. This is what happens when a fund house is low on processes and high on individuals, it could develop into a problem when the individual plans to move out.
Similarly, fund managers like Mr. Sukumar or Mr. K. N. Siva Subramanian had a free hand while managing their funds at Pioneer ITI. The latter was subsequently taken over by Franklin Templeton Investments, which has a different investment style and is therefore unlikely to afford the same kind of flexibility to these fund managers. So investors who have seen their funds perform well in the Pioneer ITI era, should not be led into believing that these fund managers will do as successfully here.
From the investor's perspective, the moot point is – how does one identify a strong process-driven mutual fund? Investors can do that by looking at consistency in the fund's performance across a longer time-frame of 3-5 years. More importantly, within this period, try to see how the fund has done across bullish and bearish phases. In a strong process-driven mutual fund you will find that even if a fund has not done exceedingly well in a bull run, it would have mitigated losses in a bearish phase. The reason behind this is disciplined fund management, a rare trait in the industry.
Let us take a few strong process-driven mutual funds to understand this better:
Sundaram Growth Fund (9.0% CAGR over 3-Yr, 19.9% CAGR over 5-Yr) was a relative underperformer in the tech rally in 1999-2000. There was a simple reason behind this. Sundaram Growth Fund has a provision that does not allow the fund manager to invest more than 5% of the fund's assets in a single stock. In a rally, should the stock appreciate beyond 5%, the fund manger must sell the stock to maintain the 5% cap. Likewise, the fund also has a sectoral cap. Obviously, this does not allow the fund to 'participate' in a rally like its peers who do not have a cap on a stock/sector.
Principal Mutual Fund is another fund house that is governed more by processes than by the fund manager's individualistic and intuitive traits. Both their diversified equity funds (Principal Growth and Principal Equity) are linked to the S&P CNX Nifty. By the Chief Investment Officer's (Mr. Rajat Jain) own admission – they are very poor market timers, which is a comforting factor for the investor because 'timing the markets' is an important tool in the aggressive fund manager's arsenal and an irrelevant one in the process-driven fund.
HDFC Top 200 Fund (earlier Zurich Top 200 Fund), 22.1% CAGR over 3-Yr, 22.7% CAGR over 5-Yr, is another fund that pursues a disciplined fund management strategy. This discipline got in the way of the fund in 1999-2000 and its performance lagged that of its more aggressive, 'fund manager-driven' peers.
HDFC Prudence Fund (earlier Zurich Prudence Fund), 21.9% CAGR over 3-Yr, 28.8% CAGR over 5-Yr, is another fund that sticks to its mandate, which is running a 60:40 (equity:debt) balanced fund. A balanced fund it maybe, but with a 60% equity component it has managed to outperform most 100% diversified equity funds over a 5-Yr time frame. Simply, what this means is that an investor in HDFC Prudence Fund by taking on lower risk has outperformed investors in equity funds who have taken on more risk. Ideally, it should have been the other way around as more equity means more risk, which must translate into more reward. When this does not happen, the diversified equity fund manager's competency comes into question.
This brings into focus the competency of HDFC Prudence Fund's fund manager - Mr. Prashant Jain. Surprisingly, Mr. Jain did not employ a complex fund management technique to post such a sterling performance, it was quite the contrary. When we asked him the reason behind the success of HDFC Prudence Fund, he replied quite simplistically, 'I think our asset allocation was reasonably well managed. We have invested according to what we have been mandated to invest. We never had the mandate to invest 80% in equities. So we do what we are supposed to do and have maintained the balanced nature of the fund.'
Since process-driven funds are not over-reliant on a star fund manager and work more as a team, the individual behind the fund's performance is rarely highlighted. A case in point is the latest factsheet of HDFC Mutual Fund, a process-driven fund house, which does not mention the fund manager names across the schemes, a common practice in the industry. That is not to say that fund houses that mention their fund managers are not process-driven, but it just gets one thinking as to what lengths a fund house will go, to project its systems and processes, rather than its fund managers.
Let us revisit a statement we had made earlier – 'In a strong process-driven company you will find that even if a fund has not done exceedingly well in a bull run, it would have mitigated losses in a bear phase.' In our process-driven funds, Sundaram Growth Fund, HDFC Top 200 Fund, HDFC Prudence, we have so far only addressed the first part – the relative underperformance in a bull phase. Let us see if these funds delivered relative overperformance in a bear phase.
When the tech run fizzled post-March 2000, Sundaram Growth Fund, HDFC Top 200 and HDFC Prudence Fund were the winners. This is because these funds were never overloaded with technology, media and telecom (TMT), the key ingredients of the tech mania. While other funds were busy offloading TMT stocks and were witnessing a sharp fall in valuations, the process-driven funds went about 'business' as usual as they never had a TMT baggage. These funds adhered to the mandate, which was to remain well-diversified at all times and in all phases. Mr. Jain underscores this point, 'The fund must maintain the mandate in line with the offer document. This is important in legal terms as well as in the spirit. That is why we never violated the 60:40 mandate in our balanced fund (HDFC Prudence Fund). Even in our diversified equity funds (HDFC Top 200, HDFC Equity Fund) at no point did our portfolio resemble that of a sectoral fund.'
Investors need to understand that risk mitigation is a very critical part of fund management and its primary objective. Delivering growth comes after that and is therefore the secondary objective. Both these objectives are tested vigorously across bull and bear phases. And more often than not, you will find the process-driven funds redeeming themselves on both these criteria more than the 'fund-manager' driven funds.