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High On Corpus, Low On Performance
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The reason for the underperformance of ICICI Infrastructure Fund has been its high exposure to the banking sector close to 15 per cent of its portfolio as on last March. Last year the banking stocks were the most beaten down with the BSE Banking Index –Bankex losing nearly 12 per cent. Therefore it brings down to the question, is it because ICICI Infrastructure Fund has a large corpus and therefore less avenues to invest in a fund like infrastructure has been the reason for the massive underperformance of the fund. Though fund manager from the fund house denies the size to be the reason for the fall. On condition of anonymity a senior fund manager said, "Its nothing to do with the corpus but the underperformance has been due to the underweight in the cement sector that has done well and to certain extent exposure to the banking stocks has been the reason for the fall." Due to the dismal performance, the AUM of ICICI Prudential Infrastructure Fund has come down to Rs 2,150 crore, as on 31 March 2012.
Though the fund house accepts its mistake of going wrong on call, it is in denial that the poor performance has nothing to do with money under management. It's not much different in the debt funds segment. For instance the Birla SunLife Dynamic Bond Fund (Birla) that manages close to Rs 5,350 crore of AUM compared to IDFC Dynamic Bond Fund (IDFC) that has close to Rs 483 crore of AUM. Last year ending March 2012, IDFC outperformed Birla by 108 basis points to record a return of 10.80 per cent compared to 9.72 per cent reported by Birla. "However over a period of five years both the funds have delivered similar return of around 9 per cent," says Renu Pothen, head of research at Fundsupermart.com.
"AUM plays a crucial role in fund management," says Waqar Naqvi, CEO of Taurus Mutual Fund who explains it by an example. If you are a lending company that has Rs 100 crore to lend you will choose from the top 100 triple ‘A' rated company for lending. But if the money increases to Rs 500 crore and you have only 200 triple ‘A' rated company then you will have to look for other companies with a lower rating and this true even in case of mutual funds and its schemes. With AUM increasing in a scheme the fund managers also looks for other companies than its core investment portfolio. "I think the best AUM size for a large-cap diversified fund could be in the range of Rs 3,000 crore, while for a mid-cap fund the AUM could be around Rs 500 crore. However for small-cap fund it should not be more than 50 crore, opines Naqvi. Though one could have argued that receiving more money in small-cap, mid-cap, thematic and sectoral fund can hamper the performance, it's not always true for large-cap fund as they still can find ample stocks that are liquid in nature. Therefore their underperformance has to do with the construct of the portfolio.
Prashant Jain, executive director and CIO at HDFC Mutual Fund whose two funds—HDFC Top 200 and HDFC Equity have an AUM close to $5 billion has a different opinion of maintaining a large fund. He says, "The challenge of managing a relatively large fund is that it takes more effort to change the portfolio. But fund size in India is quite small compared to the market itself. The HDFC Top 200 is approximately $2 billion, compared to the market capitalization of India $1.2 trillion, making it only 0.15 per cent of the market capitalisation of India. While the top holding in the fund amounts to just 0.7 per cent of the market cap which leaves ample headroom for the Fund to invest more even in its largest position." Adding to it Kenneth Andrade, head investments at IDFC AMC, "Indian businesses and companies are also growing therefore it is quite normal that AUM will also rise."
Interestingly the top 10 equity funds (see graph) that have an AUM of over Rs 3,000 crore, as on 5 April 2012 accounts for 30 per cent of the total AUM of all the 366 equity funds in the industry. Though the top 10 did well in the long term, during the bad times they have been disappointing. In the last five years from 2007 to 2011, whenever the BSE Sensex has plunged, the top 10 equity funds have been disappointing. For instance last year when BSE Sensex dropped 17 per cent for the period between 7 July to 26 August 2011, HDFC Top 200 was ranked 32 among the top 40 large-cap funds delivering a return of negative 16 per cent. Similarly in the same period other funds like Reliance Growth Fund in the mid-cap category ranked 21 among 28 funds, while Reliance Equity Opportunity, ICICI Prudential Dynamic and HDFC Equity funds in the multi-cap segment ranked 28, 37 and 40, respectively among the list of 46 multi-cap funds.
Though the objective of the fund manager is to beat the benchmark and some of the managers of larger funds have been doing that consistently, but in a downturn they lose their charm. But Jain of HDFC doesn't seem to agree. "On the contrary, large funds have generally performed better. However what happens is that when a large fund does not do well, it is noticed by more number of people compared to a small fund, and thus at times a wrong notion develops that large funds do not do well."
Catch 22 situation
In the past mutual funds have restricted inflows as they have felt it was better to keep money at manageable level rather than taking more money that would be difficult to manage. In 2005 Reliance Growth Fund has stopped subscriptions for three months when its corpus crossed Rs 1,700 crore and IDFC Premier Equity Fund in the past had restricted inflows and was taking bulk inflows but only accepting money through systematic investment plan (SIP). But good fund management doesn't always means good economics as stopping inflows was hampering business. Earlier the funds had an option to duplicate funds. For instance Reliance Growth Fund and Reliance Vision Fund the flagship funds for Reliance Mutual Fund and that were launched in 1995 saw the mutual fund in 2006 launching Reliance Long-term Equity in the mid-cap space that was an alternate for Reliance Growth Fund, while Reliance Equity Fund, a large-cap fund as an alternate for the Reliance Vision Fund. Though it could have been the step in the right direction, AMC lost the plot which was more interested in just garnering assets rather than worrying about performance. In fact regulators have taken a note of it and have already stopped this bad practice of launching multiple funds with similar objective.
In fact IDFC Premier Equity has been the best example of good management and fund performance. They have been consistently outperforming the benchmark as well as its peers following their strategy to restrict the inflow compared to someone that were accepting money in the fund like Birla SunLife Mid-Cap Fund or Kotak Mid-Cap Fund. Jain of HDFC Mutual Fund agrees that fund managers should be given an option to restrict the intake of money. "This will enhance flexibility to deal with specific situations." However in a over crowded industry, it is difficult for mutual fund to stop accepting business, but we can just hope that they are able to strike the right balance, after all their business is doing well because of performance and if that's compromised business will automatically suffer.
(This story was published in Businessworld Issue Dated 30-04-2012)