An important lesson for mutual fund investors

Dec 1, 2010

In this issue:
» India's imports versus exports - the rising gap
» Europe risks a 'slow motion wreck', says Pimco's El-Erian
» India's strong growth adds to RBI's worries
» India set to miss its power capacity deadline...yet again!
» ...and more!!

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In the world of value investing, Peter Lynch ranks right up there along with the likes of Warren Buffett when it comes to beating the market over the long term. He led the Fidelity Magellan Fund from the late 1970s through 1990. Based on his investing acumen, this fund earned nearly double the S&P 500's return on an annualized basis during these years. However, since he left, the performance of the fund is nothing to write home about.

As per latest stats, it trails around 77% of all US large-cap growth funds based on past 15 years' performance. So someone who had bought this fund in 1990 assuming past performance to continue, must be ruing his decision today.

Fortunately for mutual fund investors in India, Magellan's story offers some important lessons. Relying only on a fund's past performance and giving no importance to its manager is fraught with high risks. Like a chain is only as strong as its weakest link, a mutual fund is only as good as its manager. What matters is how long the fund manager has been managing a particular fund and what has been his track record with the same. Magellan, for instance, earned its reputation purely on the back of Lynch's superior stock picking skills. But once he left, the fund was no longer the same entity.

Taking a lesson from this, you must look at a fund manager's tenure and track record managing money for the current fund before investing in it.

 Chart of the day
Today's chart of the day shows the increasing gap between India's imports and exports of goods and services. And this signifies the country's rising current account deficit, which stands at around 3% of GDP. The concerning part is that a large part of this deficit is being funded by the short term foreign money (FIIs) and not long term FDI investments.

Data Source: ADB

India remains blissfully away from the problems of high debt, low consumption and high unemployment faced by the developed economies. It's not that these issues don't plague the Indian economy. However, a high rate of growth and growing population with rising consumption demand camouflages the problems. Nevertheless, a stubborn rise in prices, especially food prices, is a cause of grave concern. It has come to worry the central bank and the government for several months now. The RBI has been one of the most proactive central banks in emerging markets when it comes to raising interest rates. But none of its efforts have yielded the desired results so far.

The latest GDP growth numbers for India, which have beaten estimates, therefore come as a worry to the RBI. Along with rising incomes, changing diets and low farm productivity have put pressure on food prices. Thus, higher GDP growth only strengthens the chances of inflationary pressure. This calls for rise in interest costs at a faster pace if the government is to meet its FY11 inflation target. The RBI's job is therefore far from done.

Unlike the Government of India, we have always been skeptical of India's ability to grow at double digit rates on a consistent basis. Our pessimism was boosted further by an article in Mint today. It talks about how India is all set to miss the deadline it had set for itself for adding power generation capacity. As per the daily, the Government had set a target of adding 20,359 MW of power generation capacity this fiscal. However, the target has now been scaled down to 18,600 MW and it looks like even this target will not be met.

There are whole host of reasons behind the failure to put up adequate capacities. They range from shortage of power generation equipment, delayed investment decisions and contractual problems to environmental and forest clearances and natural calamities.

Things are behind schedule even on the capacity addition target set for the 11th five year plan that ends in 2012. The capacity added till date is only 29,000 MW as against the target of 62,000 MW which was again a scaled down version of the original target of around 79,000 MW. A perfect demonstration of the way things move in India we believe.

Foreign funds are increasingly gravitating towards Asia. And so are the stockbrokers. Both big investment banks and small brokers are ramping up their staff devoted to research, sales and trading of stocks in Asia. The firms have been lured by the expanding investor base here, as greater numbers of people and commercial customers look to buy or trade stocks or get research on prospects and valuations. There is a feeling that there will be limited growth in US and European markets. While in Asia, there is growth in economies and savings.

The broking firms acknowledge the rising competition but say it is better to be within Asia than out of it. It isn't clear whether the fees will stay fat in a region where commissions historically have been higher than elsewhere. However, Asia's high growth rates as well as continued issuance of new equity will keep the volumes of commissions received by brokerages on the higher side.

European countries are doing all that they can to control the mess that excess debt has landed them in. The European Union has actively bailed out Greece and now Ireland with the hope of containing the problems. However as per PIMCO's CEO, Mr. El-Erian, European countries will continue to face financial crises. This crisis can only be controlled when the individual governments actively address their debt issues and cut down on their spending.

He opines that the governments will need to be proactive rather than be reactive to contain the risk of a contagion in the zone. As per him, the bailouts are simply postponing the problems to a later date. Little is being done to address the core issue. Unless this is addressed, he says that Europe risks a 'slow motion wreck'.

Indian markets had a strong day today. The BSE-Sensex was trading with gains of around 300 points (1.6%) at the time of writing this. These gains were largely led by buying in stocks from the metal and banking sectors. Among other key Asian markets, Japan and Hong Kong closed with gains of 0.5% and 1.1% respectively.

 Today's investing mantra
"There is no shame in losing money on a stock. Everybody does it. What is shameful is to hold on to a stock or worse to buy more of it when the fundamentals are deteriorating." - Peter Lynch

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7 Responses to "An important lesson for mutual fund investors"


Dec 2, 2010

Please suggest me which mutual fund best for buy at present.


Raghava Neti

Dec 2, 2010

Great insight. Like a jewel in a box. Keep giving us
these jewels.

European region is faltering on debt management. How
are we doing in India.


ruchir shah

Dec 2, 2010

You have rightly pointed out to check the performance of the fund manager.

Do appreciate if you can also provide the site address from where on can check this as well.


Jagadeshwer Rao

Dec 1, 2010

Very True. The relevance of Fund Manager and his track record have been rightly pointed out. Hope all MF investors would take due notice of this.



Dec 1, 2010

Dear Sir,
its really help me to understand the market more closely and quickly,really a small and very eficient advice in a very short time.

Arijit Roy.



Dec 1, 2010

Beautiful is the only word


Ravi Katari

Dec 1, 2010

It certainly seemed to me when the meltdown hit the world that our renowned BLACK ECONOMY actually shielded us from most of the impact apart from our large domestic economy. I would really like to hear about any definitive study done by you, or anyone else, about the effect of the black economy and what our real BOP, deficits etc are once that is factored in.

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