A much needed reform in mutual fund industry

In this issue:
» Why the US depends on Gulf despite shale gas boom?
» Wrong valuation of assets affecting pensioners
» Foreign retailers stoking realty prices
» Will US Fed remain a profitable banker?
» ...and more!

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00:00

Gone are the days when mutual fund distributors vacationed abroad every time a new scheme was sold. New fund offers (NFOs) were their ticket to overseas vacations. No doubt the distributors were more than keen to chase investors and lure them into investing into new schemes. Needless to say the fundamentals of the scheme or the reputation of the fund house hardly mattered. Moreover, once the NFO was well subscribed nobody bothered to track the performance of the scheme. After all the AMCs were happy to have accumulated enough corpuses. The distributors were happy having enjoyed the vacation with their handsome commissions . The poor investors were left at the mercy of the fund house. If the scheme failed to offer even reasonable returns there was no compensation for the investor. The steep fees charged by fund houses to pay distributor commissions too bore a hole in the investors' pocket.

Despite protests from AMCs, Securities and Exchange Board of India (SEBI) did manage to do away with the steep entry loads and distributor commissions. This did resolve the problem of mis-selling of mutual fund schemes to an extent. NFO launches automatically dried up as SEBI's new rules made fund houses wary. Also with no commissions, the schemes failed to elicit distributor interest. But even then several non performing fund houses continued to rake in asset management fees.

Consider some statistics. Around one-third of equity schemes have underperformed their benchmark indices. Not just in the short term but also over three-year and five-year periods. According to Mint, 117 out of 329 open-ended equity schemes underperformed their benchmark indices in the past year. 98 of 298 schemes underperformed in the past three years. 80 out of 209 schemes underperformed in the past five years. Needless to say that thousands of investors who have invested in the underperforming schemes have lost trust in equities. In fact many may have resolved to never invest in equities again.

But a new diktat from the SEBI could bring in the much needed sense of responsibility amongst the laggard mutual funds. The regulator wants these fund houses to be answerable for their underperformance. If not willing to do so, they must wind up. It has pulled up several AMCs that have been managing hundreds of non-performing equity schemes for years. Plus those that despite underperformance have the audacity to seek approval for new schemes. It wants the concerned AMCs to explain why they should be allowed to charge fees despite underperformance against the benchmark index. Very rightly so! We welcome the move and believe that linking mutual fund fees with their track record is the best way to attract Indian investors.

Do you think the SEBI directive to underperforming mutual funds will be beneficial to investors? Please share your comments or post them on our Facebook page / Google+ page

01:35		Chart of the day

As pressure mounts on economic growth and corporate profitability, companies try to extract the most from available resources. Needless to say employee productivity, which is most scalable, assumes importance. As economic cycle turns, so does the impact of employee productivity on profits. Most companies these days prefer to hire during a downturn, so that they can obtain maximum value from human resources during recovery. Plus the hiring fetches best talent at reasonable costs. As seen in the chart, China and India witnessed the maximum improvement in employee productivity in 2012. The change in GDP per person employed year on year for India and China was several times that in developed nations like the US and even developing ones like Brazil and Russia. The secret to this is demographic dividend. A large population of young and employable citizens helped India and China prepare better for the economic recovery. The challenge, however, will be to retain the productivity and profitability.

Data source: The Economist

02:05

Oil is a critical commodity, not just as an energy resource but because of its wide geopolitical repercussions. For economies like Middle East, huge oil exports to other nations are the backbone. So one when comes across reports of shale gas revolution in US - the highest consumer of oil, one wonders about broader implications. These include not just demand supply trends, but also issues like US's commitment to security in the Gulf region.

One may expect that a shale gas glut might make US indifferent to oil security in the Middle East. Or that China with its growing need for oil imports may replace US in this regard. However, the actual trend suggests something different. Despite the shale gas boom, the US is becoming more and more reliant on oil imports from Gulf region. In fact, the share of Gulf oil supplies in US imports recently touched nine year high level. This is because US refineries are still tuned to process heavier Gulf oil. Hence, even though overall crude demand is down in US since 2004, the crude oil imports from Gulf are rising. Also, keeping in mind the high sensitivity of global oil prices to instability, we believe US will remain involved in Middle Eastern oil security.

02:35

The Fed's policy of keeping interest rates ultra low could be an attempt to encourage investments and spending in the US. But the strategy is having an unintended side effect. Or should we say the policy is revealing its dark side. This unwanted effect is nothing but the soaring pension gap across the US corporate landscape. You see, there are promises made by US companies that they will pay their workers a certain amount of pension after they retire. And these promises when taken cumulatively reflect on the liabilities side of a company's financial statement. Now the problem is with interest rates at all time lows, there has been a huge increase in these liabilities. The reason being that the discount rate that is calculated to arrive the present value of pension liabilities has gone down, resulting into a corresponding rise in pension liability. So, how do the companies deal with this problem? Well, they simply take a one-time charge on their P&Ls (profit and loss statements) which then affects their bottom line. Of course, the charges could also be reversed if interest rates start to climb. But this is yet another instance of how artificially manufactured interest rates lead to wrong valuations of assets and liabilities and cause anxiety to firms.

03:03

The commercial real estate market was in a downturn of sorts due to a slowdown in the IT and retail sectors. However, it seems that the retail sector is on the verge of a revival due to entry of foreign retailing companies. If you are staying in Mumbai or Delhi then you would have definitely seen Starbucks in malls nearby. Swedish furniture company, IKEA, is another foreign chain all set to expand into major Indian cities. Apart from this, various other foreign chains like Hennes & Mauritz, Hamleys, Lacoste etc have geared up to expand their India presence. Expansion by these firms is likely to increase the demand for commercial real estate. It may be noted that 2012 witnessed a weak supply of just 3.44 m sq ft of mall space in 8 key cities of India. But this is likely to increase to 12 m sq ft in 2013 amidst expansion plans by these foreign retail chains.

The government opened up the foreign direct investment (FDI) in retail recently. And this is the key reason behind such an expected improvement in demand during 2013. Increasing demand for mall space is likely to push up the leasing rates as well. Thus, it appears that 2013 could well witness a turnaround in the commercial real estate market.

03:42

We usually stress on the importance of having low levels of debt when it comes to investing in a company. The reason we say this is because a highly leveraged business is the first to get hit during times of economic downturn. This is because the companies have to consistently pay interest costs, despite lower profitability. The same point applies to a government or a central bank as well. Sometimes huge burdens of debt can turn out to be a nightmare. And this is exactly what is going to happen with the US Fed in a few years time. The Central Bank of US has been amassing ridiculous amounts of debt with its quantitative easing programs. The idea behind them is that the flood of money will stimulate the economy. Though it has so far not been successful at this attempt, it has definitely helped in increasing the mountain of debt that the US Fed has to its name. And this mountain will force it into losses by 2017 or 2018.

The US Fed has been one of the most profitable banks in the world. It pretty much pays for its own expenses and doles out a hefty dividend to the US Treasury at the end of the year. As per CNN Money, the bank has remitted an average of US$ 81 bn over the past 3 years. But as interest rates would undoubtedly increase in the coming years, this situation will reverse. The interest payments on the debt would hurt its profitability. At the same time it would have to start selling the bonds that it has been issuing. Since there would be a flood of bonds at that time, the bank would have to incur substantial losses on the sale as well. Though thanks to accounting, the bank can defer this loss and adjust it against its profitable years whenever it comes out of the books. But a book entry will not change the fact that the bank will be in losses. Pity the US policymakers are not even thinking about this aspect and are just continuing to print money recklessly. Money that is cheap but is not helping in any way to solve the purpose for which it is being printed.

04:30

After the profit booking in index heavyweights seen yesterday, buying interest has returned to select telecom, engineering, auto and energy stocks today. The benchmark indices in Indian equity markets opened on a strong note today. The BSE Sensex was trading higher by around 154 points at the time of writing. Other major Asian stock markets closed higher while markets in Europe opened flat to positive.

04:50

Today's investing mantra

"Our investments continue to be few in number and simple in concept: The truly big investment idea can usually be explained in a short paragraph. We like a business with enduring competitive advantages that is run by able and owner-oriented people. When these attributes exist, and when we can make purchases at sensible prices, it is hard to go wrong." - Warren Buffett

Warren Buffet - The Value Investor